Two compulsory lotteries

Never reason from an increase in inequality. What the effects of increased inequality are, and whether it's good or bad, will depend on what caused that increased inequality. Inequality is an endogenous variable.

So let's think of a government policy that would cause increased inequality, and talk about that.

Suppose the government gave every Canadian a "free" lottery ticket. It isn't really free, of course. Those "free" lottery tickets are financed by increasing taxes. Maybe by increasing GST (VAT). If each ticket has an expected value of $1, and you get one ticket per day, and there is one winner every day, the prize would be around $35 million, and your chances of winning the lottery during your lifetime would be around one in one thousand, or 0.1%. You too could become a 0.1 percenter!

1. Would that government policy be an unpopular policy?

Probably yes, otherwise governments would probably already being doing that policy. But the answer isn't obvious to me. A lot of people buy lottery tickets, and gamble, at much worse than actuarily fair odds. They would presumably like the policy.

2. Would those people who care most about inequality be those who would be most opposed to that government policy? And would those people who are least concerned about inequality be those who would be least opposed to that policy?

The answer to that one is not obvious to me. (Personally, I would be very strongly opposed to that policy, yet I am perhaps less concerned about inequality than most.)

3. Does that government policy increase or reduce inequality?

Every individual gets a lump-sum transfer payment worth $1 per day, financed by a tax that is (very roughly) proportional to consumption, so the rich pay more. If lottery tickets could be sold, or if there were actuarily fair insurance against losing that lottery, it would be the same as giving each individual a (rather small) Guaranteed Annual Income (Negative Income Tax) of $365 per year financed by a (roughly proportional) consumption tax. Which reduces inequality. But if the lottery tickets are non-transferable and non-insurable, you can't avoid playing. It's a compulsory lottery. The compulsory lottery will cause increased observed inequality of wealth and disposable income.

4. Did the 0.1% who won the compulsory lottery do anything to deserve their wealth?

Well, they were Canadians who paid GST. But so were all the other Canadians who paid GST who didn't win the compulsory lottery. So no.

5. Is this imaginary compulsory lottery any more fair than the other real-life compulsory lottery in which some people get rich by being lucky: by being born to the right parents or born with the right abilities or just being at the right place at the right time?

I would say no. But it's a strangely metaphysical question, about determinism and identity. Some people are born with a winning lottery ticket number.

6. Would you resent the 0.1% who win this compulsory lottery as much as you resent the 0.1% who win the other compulsory lottery?

I bet you wouldn't.

Why? Because you know they are no better than you, and you know they know it too, and you know that everyone knows they are no better than you. Everyone knows they just got lucky.

"I'm richer than you because I'm better than you."

"I'm richer than you because I'm luckier than you."

7. Which one makes you resent me more?

8. Or is it because you might still win the first imaginary compulsory lottery, but already know whether you have won or lost the second real-life compulsory lottery?

But is this a moral question, or just about you? Wouldn't it be an even better compulsory lottery if you got the prize earlier in life so you could enjoy spending it while you are young enough to enjoy it?

9. Or is it about procedural fairness, and nothing to do with inequality of outcomes?

But is my first imaginary compulsory lottery any more procedurally fair than the second real-life compulsory lottery? We are forced to pay taxes to pay one lucky person $35 million in the first compulsory lottery. Where's the procedural fairness in that? I could at least avoid paying for the second compulsory lottery by only buying goods from people who are not part of the 0.1%.

(All the other econobloggers seem to be doing posts on inequality, and since I resent their success I decided I would re-cycle/re-use my old post to try to keep up with the Joneses.)

Comments

[Roger Sparks]

A clever way to initiate discussion!

Wonder if government simply borrowed or printed to obtain the prize? Over time, government would get all the money back, using only existing taxes, as each successive holder of the winnings paid his or her taxes! (we only need one winner here, who presumably spends his winnings.)

The wealth of the economy would increase, for a while, until taxes reclaimed the wealth. People would work more, until the money supply fell from tax withdrawal.

The withdrawal effects would occur over a very long period of time!

[Jeff]

Nick,

"I bet you wouldn't."

I think you might have it exactly backwards. Think about elites who are clearly, indisputably better than us. Do people ever feel resentful towards LeBron James or Sidney Crosby (or since you're a Brit, David Beckham or George Best)? How about Stephen Spielberg or Keith Richards? Or Steve Jobs? I think it's exactly the people who we *know* are just unequivocally better than us who we don't resent in the least.

I think the resentment arises from the suspicion that somebody, whether by virtue of skill, luck, or just basic ruthlessness, is monopolizing some rent that the rest of society is forced to pay (like your lottery). Think of Jamie Dimon or Bill Gates 20 years ago. I don't think that's an irrational emotion.

[Nick Rowe]

Roger: if the government wanted to borrow and/or print, it wouldn't need the lottery. Just give every Canadian $1 per day. Or cut the GST the same amount, and then you get the supply-side benefits too.

[Nick Rowe]

Jeff: fair point. But I always tell my students this example: suppose Wayne Gretzky had been born in England, the same time as I was. Nobody would have paid him megabucks for his skating skills. He just got lucky, to be born in Canada, where those same skills were worth a lot. OK, he worked hard too, but that wouldn't have been enough if he had been English.

But your point is still correct. We don't resent the lords of the ice rink and the stage and screen the way we resent other successful people. And, or so I've heard, people didn't use to resent the old aristocracy who were born to wealth the way they resented the capitalists who made their wealth. I wonder why we resent some and not others?

[Patrick]

I don't agree that people mostly resent rich capitalists. Quite the opposite. Most people think pretty well of the capitalist who builds a business and gets rich engaging in mutually beneficial, honest trade. What I think they resent is when the rich assert or act in a way such that the usual norms of fairness and even legality don't apply to them because they are rich (think CEO who tanks the firm, screws the pensioners, but makes off with millions). Also, not acknowledging the element of luck involved or that their success is in no small measure due to them being part of a larger community, to which they have responsibilities and duties. Standard fare for traditional Tories, I believe.

Guys like Gretzky (or Beckam, or ....) play with the same rules as everyone else playing the game. It's the same for them as for e.g. an 8 year old kid. So despite the stupid amounts of money they make, it doesn't strike people as being worthy of resentment - so long as they really are better at the game.

[Nick Rowe]

Patrick: we understand the rules of hockey or soccer, and we understand who is good and who isn't. At least, we think we do. We don't understand the rules of finance, so we are suspicious of people who make their money that way. "I don't understand it, so it must be a way to make money at our expense!". (There is a long tradition of resentment at moneylenders, of course.)

But is it obvious that Gretzky and Beckam aren't playing by rules that let them get rich at our expense? If we changed the rules, with salary caps, or more NHL teams, or unlimited substitutions, etc., might some of those rule changes make the stars poorer but the fans richer?

[Patrick]

Sure, fair point about money lenders. Though, I just watched "It's a Wonderful Life", and everyone in the movie and the audience seemed to think George - who was a money lender - was a good guy. But Mr. Potter? Not so much. What was the difference, I wonder?

I don't know about rule changes etc for pro sports. I think the whole thing is silly. FWIW, Seems to me that the only thing that matter is that the tribes who follow it are content with the fairness of the thing. Whether it really is or isn't doesn't matter,

[Jeff]

Nick,

"But your point is still correct. We don't resent the lords of the ice rink and the stage and screen the way we resent other successful people."

But that wasn't my point. I also threw Steve Jobs into that list. My point is that the consumer surplus I derive from my iPhone or my old Stones records is orders of magnitude more than what I paid for them. It's all about Pareto exchange versus theft. Think of Bill Gates in the '90s who, in contrast with Steve Jobs at his peak, was widely despised. Why? Because he exploited a natural monopoly to foist an abysmal technology on the world, while ruthlessly crushing technologically superior competitors. There was nothing better about MS-DOS in 1985 than any of a number of other competitors but Microsoft had the monopoly (because IBM gave it to them). So we paid them hundreds of billions of dollars of monopoly rents (negative consumer surplus). And technologically savvy people rightfully resented them for those rents and what they did to the industry.

"people didn't use to resent the old aristocracy who were born to wealth the way they resented the capitalists who made their wealth."

The industrial revolution created capitalists and it also transitioned labour from the farm to the factory. I wonder if it was the experience of the capitalist monopoly power in the labour relationship (rather than the consumer relationship) that caused the resentment: imagine your five year old kid working in the coal mine. I'd bet there was plenty of resentment towards the land owners too, back when they were the only employer (weren't there a few revolutions fought over that?)

"We don't understand the rules of finance, so we are suspicious of people who make their money that way."

I doubt it. I've spent half my life in the industry. I didn't get *less* suspicious.

"I wonder why we resent some and not others?"

Theft, fraud, abuse, etc.

[Nick Rowe]

Jeff: "Theft, fraud, abuse, etc."

I wonder. What about mafia types?

And BTW, to all: would you be strongly opposed to my imaginary compulsory lottery, and if so, why?

My reaction is to be strongly opposed:

1. The economist in me doesn't like the distortionary increased GST tax being used to finance transfer payments that will have a very low Marginal Utility (diminishing marginal utility of consumption).

2. The libertarian in me doesn't like the idea of people being forced to buy a good that many of them don't want, and who could buy themselves in a voluntary lottery if they wanted it.

3. The paleo-conservative in me doesn't like people gambling in fake dreams to get rich when they should be working hard and saving if they really want riches.

Inequality per se doesn't enter into it, except indirectly in 1.

[Jeff]

"What about mafia types?"

Are you saying we don't hate them too? Along with corrupt politicians and civil servants, isn't organized crime at top of the list?

"would you be strongly opposed to my imaginary compulsory lottery, and if so, why?"

Yes!

The social planner should be an (intertemporal) utilitarian. This does not increase utility. That's all.

You have not addressed the Steve Jobs example. Would it be correct to observe that you have scaled back your thesis from "we are resentful of rich people because they are better" to "we are resentful of people who work in finance because we don't realize how much value they add?" In which case, do you agree that it is rent seeking that we abhor (even if we don't always identify it correctly)?

[Min]

"Never reason from an increase in inequality. What the effects of increased inequality are, and whether it's good or bad, will depend on what caused that increased inequality."

What the effects of increased inequality are, and whether it's good or bad, will depend, **in part**, on what caused that increased inequality.

There. Fixed that for you. :)

[Nick Rowe]

Jeff: I think it depends on who the "we" is.

Your utilitarian social planner dislike of the compulsory lottery is the same as my 1. economist's dislike.

I don't know whether people like or dislike Steve Jobs. If they do like him, I think it might be because he's the little battler (Aussie phrase) going up against the Microsoft establishment. People like to cheer on the unorthodox challenger against the boring old establishment champ.

But I'm really not sure whether you or I are representative of those who most like inequality, or who say they do. I don't like rent-seeking. But I'm not sure if the dislike of rent-seeking is what is behind people's dislike of inequality.

[Jason]

I think #6 gets at Noah Smith's inequality of respect:

http://noahpinionblog.blogspot.com/2013/12/redistribute-wealth-no-redistribute.html

If more of the 0.1% went around saying they were incredibly lucky rather than better than others I bet inequality would be less of an issue.

However, I think your thought experiment focuses on the amount of money not the function of money ...

http://informationtransfereconomics.blogspot.com/2013/12/three-inequality-analogies.html

[Min]

Jeff: "Think of Bill Gates in the '90s who, in contrast with Steve Jobs at his peak, was widely despised. Why? Because he exploited a natural monopoly to foist an abysmal technology on the world, while ruthlessly crushing technologically superior competitors. There was nothing better about MS-DOS in 1985 than any of a number of other competitors but Microsoft had the monopoly (because IBM gave it to them)."

What was so natural about the Microsoft monopoly? I remember trying to buy a computer with Dr DOS installed on it instead of MS-DOS, by a seller who advertised that. To my surprise, he was going to charge me $99 for Dr DOS. At the time, you could buy both Dr DOS and MS-DOS off the shelf for $99. When I pointed that out to him and asked why he was charging extra for Dr DOS, he replied that his contract with Microsoft required him to pay them the same amount for each computer he sold, even if it did not have MS-DOS installed on it. What's natural about that?

[Nick Rowe]

Min: "natural monopoly" in the sense of a downward-sloping ATC curve, presumably. Or network externalities, maybe.

[Min]

Speaking of resentment, you gotta love this:

"I gotta say there is nothing more grotesque than walking down market st in San Francisco. Why the heart of our city has to be overrun by crazy, homeless, drug dealers, dropouts, and trash I have no clue. Each time I pass it my love affair with SF dies a little.

"The difference is in other cosmopolitan cities, the lower part of society keep to themselves. They sell small trinkets, beg coyly, stay quiet, and generally stay out of your way. They realize it's a privilege to be in the civilized part of town and view themselves as guests. And that's okay."

-- Greg Gopman, CEO of AngelHack

[Jeff]

"People like to cheer on the unorthodox challenger against the boring old establishment champ."

Sure, but if you remember, everyone hated IBM before Microsoft almost killed them, and that didn't make everyone love Bill Gates. I also doubt that anyone is resentful of Elon Musk although he didn't battle or harm any established players. Because he created great stuff.

"Your utilitarian social planner dislike of the compulsory lottery is the same as my 1. economist's dislike."

I thought it was, but since you didn't explicitly mention the disutility of the tax, I thought I'd make it clear. The libertarian argument, to me, is mostly justified by the utilitarian one (first welfare theorem). The only one I don't agree with is the paleoconservative one. I don't care what people want to do with their time, though I am concerned that they might make some bad choices if the state doesn't at least nudge them in the right direction (liberal/utilitarian version of your paleoconservative argument).

"I'm not sure if the dislike of rent-seeking is what is behind people's dislike of inequality."

I'm not sure either, but I think unjust gains ("rent" to you and me) are a big part of it. You said yourself that the thinking was: "I don't understand it, so it must be a way to make money at our expense!" I.e. people get angry because they think they've been had. But this claim seems a very far cry from "I resent them because they are rich because they are better," for which you've provided very little evidence (and there are lots of counterexamples). Really it's: "I'm not sure exactly what happened here, but I'm pretty sure I got screwed".

[Min]

Nick Rowe: "natural monopoly" in the sense of a downward-sloping ATC curve, presumably. Or network externalities, maybe.

Well, Microsoft built its monopoly on the good will of IBM and IBM-DOS, when IBM got out of the PC market and sold them the rights to IBM-DOS. After that, the monopoly persisted on restraint of trade. IMO.

[Jeff]

Min,

What Nick said. All software has essentially zero MC curve, but operating systems additionally have huge network externalities (like roads,
utilities and other natural monopolies). It's very inefficient to have more than one. And as you say, Microsoft went out of its way to leverage its monopoly power by rendering competing products incompatible. If it hadn't been for antitrust law, they would have killed Apple and lots of other great companies (apart from the ones they actually did kill).

"Microsoft built its monopoly on the good will of IBM and IBM-DOS, when IBM got out of the PC market and sold them the rights to IBM-DOS"

This is OT, but that did not happen. Microsoft bought DOS from a third party for peanuts in 1981 and licensed it to IBM. IBM built its PC business on an OS that it didn't own and which, when licensed from Microsoft, had been created in a few months. Then IBM became dependent on the OS. IBM's gross incompentence was a stroke of huge luck for Microsoft.

[rsj]

Here is my end of the year rant:

I think the problem here is that macro-economics dismisses (and trivializes) the most important part of economics, namely production. There are no micro foundations on the production side. But running a business is a difficult thing to do, with a lot of guesswork and often ruinous decisions.

So suppose that a business consultant reviews a firm and determines that it is overstaffed. If they fire 20% of the workforce, revenue will decline by only 5% and profits will go up by 15%.

The question is who captures this gain? Or, said another way, who is paid, on the margin, to shift the firm from a less productive mode of operation to a more productive one?

Under capitalism it will be the owners of the firm who benefit from this reorganization. Wages will not increase to match the increased productivity of this better organizational system. It is the very fact that wages do not increase that incentivizes the firm to make itself more efficient by laying off workers, which allows for productivity growth in the first place. And there is no market force that would force the firm to pay a higher wage to the employees that remain, even though this smaller workforce has a higher marginal value product.

Now imagine that every firm is always trying to make itself more efficient, and that productivity is generally improving by means of introducing labor saving technologies. Over time, the owners of capital would capture a greater share of total output. Unless there were some countervailing non-market force that would basically force the arbitrageurs to share their rents with the rest of the economy.

The CEO of facebook is worth many billions of dollars for inventing facebook. Here, too, there was an arbitrage opportunity, with an improved technology over what had previously existed (myspace). Those who exploited this opportunity received enormous windfalls. Only a small proportion of this windfall was passed to the employees of facebook who did the work. Those who identified and exploited the market opportunity received most of the gains.

But the above process is invisible when you assume that optimization problems are solved for free on a volunteer basis by all-knowing economic pixies who do their work in zero time. It is only by adopting this style of magical thinking that you can focus with absurd intensity on consumption smoothing as the key work of economic agents.

In our economy, optimization problems are only ever approximately solved, and each successive iteration on a better solution provides substantial windfall to arbitrageurs. While the roadside is simultaneously littered with firms who tried to optimize a bit better and failed. It is very risky and costly to optimize, with huge windfalls for some -- this is your lottery.

The optimum way of organizing our human resources when combined with nature will never be known -- we are just scratching at slightly better ways of doing this than preceeding generations. Who knows where we will be a hundred years from now in our ability to extract resources from nature and shape them for our needs. We might be creating our own universe in a basement -- our potential to produce is unlimited.

The problem is how to redistribute some of the gains of the successful optimizers while maintaining a system that invites further optimization. I think it's pretty clear that we would still have banking and innovation even if we didn't have any billionaires, but only millionaires. But in order to model these tradeoffs, we have to make models without magical pixies doing all the hard work of capitalism.

From the point of view of macro economic management, in order to have overall productivity growth you need a large middle class that can purchase mass produced goods in large quantities that are delivered at declining average cost. Economic growth is undermined when there is no countervailing trend forcing the arbitrageurs to relinquish some of their economic profits and allow for the expansion of markets.

The high inequality/low income equilibrium is when a group of landed gentry control all of the capital and labor works a subsistence wage. Because there is no market for mass produced goods, no increasing return firms can form. The skills of the nation are in bespoke items and handmade items of craftsmen who dote on the oligarchy even as national productivity stagnates.

The low inequality/high income equilibrium is when those finding marginally better solutions to the optimization problem get millions, but not billions, with the rest of the proceeds shared directly with labor as a result of union power or redistributed as income grants by the government. That allows for a large market for mass produced goods which in turn allows more increasing return enterprises which allows for more productivity growth, etc.

But I think to really study this, you would need to first stop assuming that the best way of putting our human and natural capital to work is known for free to everyone instantly at all times, while succumbing to an onanistic (and dehumanizing) focus on intertemporal optimization of consumption -- something completely unimportant to the development of the economy, when the real engine of growth is intimately died to the capture of rents.

I don't see how you can really grapple with inequality with the current toolset, in which one assumes that there are no rents.

TL;DR; Let's first talk about an economy in which rent capture plays a central role and then we can discuss inequality sensibly.

[Nick Rowe]

rsj: re-read your comment, replacing "labour" with "land" throughout. It works just as well.

You can also re-read it with "capital" replacing "labour", but here you have to be careful to distinguish bondholders, shareholders, owners of machines the firm rents, and the managers of the firm.

The Austrians would love a lot of what you say there. Because you are talking about the *process* by which *entrepreneurs* (who are not the same as owners of capital, though owning capital, labour, and/or land may help you in being an entrepreneur) grope their way towards solving the optimisation problem.

"But I think to really study this, you would need to first stop assuming that the best way of putting our human and natural capital to work is known for free to everyone instantly at all times..."

That is pure Hayek.

(You get the interaction between wages (and rents) and marginal products a bit wrong though. And we *want* entrepreneurs to capture the rents they create, to give them the incentive to search for better ways of doing things. The big problem is that those rents are too transitory, if others can simply copy what the entrepreneur has done, and compete away those rents.)

Most macro models do ignore entrepreneurship. Exceptions would include Schumpeter, and Arnold Kling's PSST. David Andolfatto's search models can also be read in that same light, if you read them as very very abstract metaphors for entrepreneurial searching for profitable opportunities.

I think that stuff is very important. Do I think it is important for short run macro of business cycles? Generally not. But sometimes I think it might be, like when I did my post on hybrid AD/PSST macro a couple of weeks back.

[Mike Sax]

I'm not sure if knowing someone really is better than you induces more resentment than knowing that they just got all the breaks.

Maybe the feeling varies among people. In the experiment there's less resentment as everyone plays by the same rules and anyone can in theory win. This is why most of us still believe in the free market system-we want to be part of the 1 percent too.

I will say this, personally, when one of these know it all economists try to tell me that I'm not worthy to have a conversation with them because they're brilliant economists and I'm not this gets me very resentful. For a few reasons. One is it's not true but is rather a crude dodge when they don't like my questions or my point. I could name names but I think you could guess who I have in mind.

Also because they're policy prescriptions make things worse for people who haven't made it-make it harder for them to move up the ladder of success.

It seems that as far as that goes there is some significant 'upward rigidity'-regarding upward mobility in the U.S. certainly. It didn't used to be this way, over the last 30 years we've seen it rise sharply.

I appreciate your honesty Nick in that you aren't concerned by inequality but part of me in hearing that just thinks: 'Of course, why would he be? He's got a comfortable life knows no economic want so it must be easy to be unconcerned.'

[Nick Rowe]

rsj: let's think of a simple example.

Suppose some entrepreneur comes up with a brilliant new idea that can increase productivity of all labour, land, and machines, right across the board. If it is applied right across the economy, and if the supplies of labour, land, and machines stay the same (they won't, but let's keep it simple), GDP would rise by 10%.

Who would get that 10% increase in GDP? Would the entreprenur who came up with the idea get it all? Not unless he can patent that idea. If he can't patent it, everyone will instantly copy it, Marginal products of labour, land, and machines will rise to soak up the whole 10% (I'm assuming constant returns to scale technology), and the entrepreneur gets nothing.

Now ask the normative question: how much ought he get?

Or, how much do you think we would want him to get, if we wanted to encourage people to spend their time thinking up other ideas like that?

[Nick Rowe]

Mike: "I'm not sure if knowing someone really is better than you induces more resentment than knowing that they just got all the breaks."

I'm not sure either. I thought I was when I wrote the post, but now I'm not. Partly the comments giving counterexamples. I think it can go both ways. It depends on something, but I can't figure out what that something is.

"I appreciate your honesty Nick in that you aren't concerned by inequality.."

That is not what I said. I said: "yet I am perhaps less concerned about inequality than most."

And the argument that "he's only unconcerned about inequality because he's rich" cuts both ways. We could equally well dismiss someone who is concerned about inequality by saying "he's only concerned about inequality because he's poor". In both cases it's as likely to be special pleading in one's own interest, from one's own perspective. That to me is the appeal of the Rawlsian Veil of Ignorance thought-experiment. Even though it is only a thought-experiment, it's better than nothing, to at least try to imagine yourself equally likely to be born into anyone's shoes when the Veil is lifted.

But if you really want to see my argument about what people actually do behind the Veil of Ignorance, I would strongly encourage you to read my old post here.

And in terms of policies that we could implement easily, at negative cost, that would make a big dent in some of the worst cases of inequality/poverty, I think NGDP targeting comes very high on the list.

[steve]

1)The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.

Lord Acton

The idea that finance is different is not new. Many past recessions have been precipitated by the financial sector, yet they always seem, just like now, to end up back on top with all the money. To the extent that envy or resentment is part of the concern over inequality, I think it is largely aimed at the finance sector and not at entrepreneurs.

2) I think there is valid concern that at extremes, inequality will allow a very few wealthy families to have outsized influence on the political process. Perhaps I am wrong, but I dont really sense resentment towards the university professor making big bucks or the businessman or physician or architect or etc. If you are making $200k a year you cant buy a senator or even a congressperson. If you have a few billion in the bank? You bet.

Steve

[Roger Sparks]

Back to your original proposal of a lottery prize financed by the GST, is it a proposal resulting in an increase in inequality?

Obviously, YES. The winner has a better life while everyone else pays more tax.

And, there are no compensating benefits of increased employment. The supply of spendable funds has stayed the same.

Wait! If each person as he pays tax, receives less, then each person must work harder to achieve his desired level of consumption! The winner now becomes a new employer as he spends his winnings, and everyone else works harder to recover the tax extracted to finance the prize. So, there is a compensating benefit of more employment.

[Roger Sparks]

Nick commented:
"rsj: let's think of a simple example.

Suppose some entrepreneur comes up with a brilliant new idea that can increase productivity of all labour, land, and machines, right across the board. If it is applied right across the economy, and if the supplies of labour, land, and machines stay the same (they won't, but let's keep it simple), GDP would rise by 10%."

I doubt this premise. I think GDP would remain unchanged because product prices would decline but the number of transactions would increase, resulting in a return to equilibrium.

I would expect the inventor would receive some benefit initially, but as you surmise, the knowledge would soon become available to all, to the benefit of all who are willing to adapt and accept.

[Jeff]

Nick,

"It depends on something, but I can't figure out what that something is."

But you answered it yourself! : "I don't understand it, so it must be a way to make money at our expense!"

Yes, you also appear to be expressing a view that finance profits constitute the producer surplus from a Pareto exchange (which is a different debate), but you acknowledge that it is the *suspicion* of a theft (rent) of some kind that produces the resentment. (And it's easy to get suspicious, what with the fact that citizens are legally forced to deal with financial institutions (deposits, registered investments, managed pensions, etc), are at a huge informational disadvantage in those exchanges, and have no say in the price of deposit insurance or trillion dollar bailouts.) So with the (acknowledged) counterexamples to your original hypothesis, and you coming up with the answer yourself, where is the mystery?

"Or, how much do you think we would want him to get, if we wanted to encourage people to spend their time thinking up other ideas like that?"

In theory this is not a difficult question. As always, he should get his marginal product. I.e. how much less output do we get if we wait until someone else comes up with the same idea? That gives him 100% of his marginal product. Back in the 18th century when people were actually patenting real inventions US patents and copyrights were good for 14 years. Now patents are 20 years (in most cases about 19.99 years longer than the time required for someone else to come up with the same idea), and copyright is good for 120 (just in case you were even *thinking* about making a movie about a funny mouse). There is no proportionality between the difficulty of the invention and the term of the monopoly. You just have to clear the same hurdle as Amazon's "1-click shopping" patent and it's yours for 20 years. If you want to actually encourage innovation, what you need to do is to drastically *curtail* IP rights to remove the legal threat to real entrepreneurs from rent seeking patent trolls.

But that only answers the question of how to set the term of unnatural or legal monopolies. We still need to decide what to do with natural ones like the traditional downward sloping ATC curve or the newer kind with network externalities (inverse parabola shaped demand curve), including platform technologies like operating systems, network protocols, hardware platforms or software APIs. If more than one producer is inefficient the only acceptable option may be public provision or completely open standards (no copyright or patent protection for dominant platform technologies). The idea that we can't have great things without bazillion dollar monopoly rents is defied by abundant counterexamples like the internet, the web and Linux (including the open source Android operating system). In fact, in recent history some of the greatest and economically most transformative things have been developed in public and given away for free.

[rsj]

Or, how much do you think we would want him to get, if we wanted to encourage people to spend their time thinking up other ideas like that?

The 'moral' answer is that being paid to come up with ideas is a pretty luxurious position to be in, so you would pay them what you pay a professor, for example. Many people are dedicating long hours of work to be professors and add to humanity's stock of knowledge in exchange for a simple middle class lifestyle. Fleming didn't get much more for Penicillin.

Moreover, it is not necessarily about *adding* to GDP per se -- you can just as easily be taking money away from existing firms. You cannot point at the market value of a firm and say that without this firm, GDP would be that much less.

For example, when you have natural monopolies, even the smallest difference can result in large windfalls. Myspace pages were ugly. Facebook realized that you don't really want to allow people to design their own pages -- that by forcing everyone to use clean, well-designed templates, the overall site would be more popular. That innovation -- removing functionality from myspace -- was worth $135 Billion because it tipped the balance away from myspace and towards facebook.

[Jeff]

"That innovation -- removing functionality from myspace -- was worth $135 Billion because it tipped the balance away from myspace and towards facebook. "

Indeed. There are plenty of secure open standard distributed social network platforms that cannot take off because Facebook controls the space. The social network *could* have been as free as the web itself. Instead users pay the monopoly rents via ads as well as getting their privacy compromised by the NSA.

[Kaleberg]

It's an interesting thought experiment, but I wonder how different it would be if you simply applied the same tax and gave each Canadian $1 a day, or perhaps $365 a year. It would be a similar income transfer, but each lottery player would have fixed government guaranteed winnings, just like a member of the 0.1% now, though at a smaller scale. My guess is that most would simply spend the money on goods and services. That would have a huge multiplier. A lot of the better off would simply save the money, moving it into the financial system storage loop where it is sequestered from the economy, but even some wealthy sorts are likely to blow it on a bottle of champagne or the like. Needless to say, the government might be able to pay for this from the increased GST revenues.

That's a lot different from the $35M lottery winners who would likely spend a fair bit up front, but then leave the rest of their winnings sequestered, most likely for multiple generations as a fortune of that size would result in a sizable estate. The impact on the economy would be much smaller, though some individuals would benefit greatly. The government would recover little in terms of GST from the increased spending.

Another way to look at it is to consider the median income. The uncertain lottery has little effect on the median income, while a broadly distributed lottery has a much larger effect. Anyone who looks at an average rather than a median when looking at well being is just being silly.

[Min]

Nick Rowe: "Suppose some entrepreneur comes up with a brilliant new idea that can increase productivity of all labour, land, and machines, right across the board. If it is applied right across the economy, and if the supplies of labour, land, and machines stay the same (they won't, but let's keep it simple), GDP would rise by 10%.

"Who would get that 10% increase in GDP? Would the entreprenur who came up with the idea get it all? Not unless he can patent that idea. . . .

"Now ask the normative question: how much ought he get?

"Or, how much do you think we would want him to get, if we wanted to encourage people to spend their time thinking up other ideas like that?"

Well, indications from cognitive psychology and from history before there were patents suggest that inventive people take very little encouragement to invent. We may also look at modern stand-up comedians. Even though their works are covered by copyright, in practice they have little protection from having their jokes stolen. In addition, IIUC, current intellectual property rights inhibit innovation more than they encourage it.

So my guess is that innovators should get more than is necessary to encourage innovation, but less than they do now.

[Nick Rowe]

IMO the big problem with long patent life is the "rush to invent". If this entreprepeur/inventer hadn't thought of it, someone else would have thought of it independently a year or two later. Why should the first one get the benefits forever?

The stock of "ideas waiting to be thought of" (please excuse the dubious metaphysics there) is like a scarce common property resource, that is subject to overfishing if the reward to catching fish is too high. Everyone wastes resources in the race to be the first one to catch the fish.

[Min]

Jeff: "Microsoft bought DOS from a third party for peanuts in 1981 and licensed it to IBM."

Thanks for the correction. :)

[Min]

Nick Rowe: "The stock of "ideas waiting to be thought of" (please excuse the dubious metaphysics there) is like a scarce common property resource, that is subject to overfishing if the reward to catching fish is too high."

If you don't mind a personal observation, Nick, I am surprised to hear that coming from someone as creative as you.

[Nick Rowe]

Min: I never mind a personal observation. If it flatters me. Thanks!

[rsj]

Let's not focus too much on invention because when discussing the very wealthy, we are not really talking about inventors in the technological sense, but winners in the game of market competition.

E.g. say you have a town with three newspapers. Because there are declining average cost curves, you will generally end up with only a single paper. Who decides what the paper will be? It could be a combination of luck, or possibly one of the papers is a little better in the absolute sense, or perhaps one of the papers is a little better in the relative sense (e.g. other papers screw up a bit more).

But for whatever reason, there will emerge a winner, driving out the other papers, and that winner will obtain a substantial windfall by virtue of being the winner, even though the net social product provided by the winner might be small or non-existent.

In this sense, there is no relationship -- not even a theoretical one -- between one's contribution and their pay.

It's like economic geography -- in one area, for some reason, certain types of manufacturing firms agglomerate, and landowners in that area receive huge gains. It's not really fair to try to analyze these gains in terms of the contribution of the landowners to the nation's output. Maybe they did make some contribution, but it's irrelevant, as you should model this as a lottery.

In the same way, market competition creates a lottery system, even if there were no innovation whatsoever.

[Nick Rowe]

rsj: OK. Your example of the newspaper natural monopoly is like the Microsoft example Min and Jeff are discussing above.

[J.V. Dubois]

In general I think that there are at least two types of inequality. There was a very good post about that here on WCI by Stephen Gordon.

1) The first type of inequality is the one that is most often used and also most important to regular people in a similar way that price of often purchased good is important for general feeling of "inflation". I think it was in Freakonomics where it was said that the most important objects comparison of status of anybody in your average family is the one between you and the husband of your wife's sister. This is where your regular envy is aimed most often. Coworkers do not envy CEOs pay, they resent if their peers in the same position have more for the same job. Top-end income is important from resentment point of view only if earned dishonestly or if used blatantly to bend already established rules. Which brings us to #2

2) "Top-end" inequality. And to be honest this is the inequality that I personally fear most. Not because of envy or anything like that. It is just my view that too much power which comes with wealth concentrated in too few hands is dangerous for democracy and to fair society in general.

[Nick Rowe]

JV: Yep. I reckon the easiest way to avoid rivalry with one's siblings and in-laws is to do something so totally different that you can't compare success. My family are all farmers, so no comparison there!

[Bob Smith]

Nobody resents Steve Jobs, Bill Gates (although they may not like his products), Lebron James or Wayne Gretzky. For the same reason, despite the fact that they're probably well ensconced in the 1%, nobody resents their dentist or their doctor. Because they're real people.

What people resent are caricatures of the "Rich" or the "1%" which may well reflect real life people, but which are hardly representative of the broader group. So we hate the generic "Wall Street Banker" or "Fat-Cat Financier" (which caricature probably hasn't changed much since Christ drove the moneylenders from the temple).

Think about Patrick's comment: "What I think they resent is when the rich assert or act in a way such that the usual norms of fairness and even legality don't apply to them because they are rich (think CEO who tanks the firm, screws the pensioners, but makes off with millions."

Have you ever heard a Wall Street plutocrat (outside of explicit caricatures of the Gordon Gecko variety) assert that the "usual norms of fairness" (as an aside, what are the "usual norms of fairness", fair being a four-letter word and all) or "legality" didn't apply to them? I mean seriously, even the ones who are actually crooked don't actually say that. How many CEO's have intentionally "tanked" the firm to make off with millions? (To be sure, lots of CEO's have been handsomely compensated despite their naked incompetence, while their firms tanked, but I don't think its' fair to suggest that they didn't try to prevent it - they just won the "lousy corporate board" lottery). And while it's entirely fair to resent CEO's who watched their companies go under, can anyone really assert that that's representative of most CEOs? Patrick's right in his description of who we resent, they're just not real people, but a figment of our own prejudices.

You see this in other areas. Read the comments section of any of our major newspapers after an article of politician salaries. My god, do Canadians resent politicians. They're overpaid, they're lazy, they're corrupt, god knows what else. In reality, most politicians are honest and hard working (if, often, none-too-smart) and, frankly, given the hours they work and the work they do, probably badly underpaid (one could probably toss in a lot of public sector workers here too). No one thinks their own MP is an overpaid fat-cat. But, good lord, do we hate generic politicians. That isn't to say that there aren't individual politicians (or public sector workers) who are overpaid, lazy, greedy, whatever (think of this year's Senate scandal), but what people resent aren't the individual ne'er-do-wells, it's the caricature of politicians.

Coming back to Nick's original post, no one will resent the lucky winner of the compulsory lottery (at least not on that basis alone) because there's no caricature of the evil lotto winner.

Steve: "I think there is valid concern that at extremes, inequality will allow a very few wealthy families to have outsized influence on the political process. Perhaps I am wrong, but I dont really sense resentment towards the university professor making big bucks or the businessman or physician or architect or etc. If you are making $200k a year you cant buy a senator or even a congressperson. If you have a few billion in the bank?"

Try reading the comments section of an Ontario newspaper after the provincial government publishes it's annual "sunshine list" (listing the salaries of all public sector employees making more than $100K). People don't resent university professors, physicians or architects because there's no caricature of the evil professor, doctor, or architect. But tell them that "public sector" workers are making 6-figure salaries (some of it richly deserved, some of it not so much), it's a hate-on. Think of the public perception of lawyers. People who have never met a lawyer hate lawyers. Not when he's trying to get you out of a drunk driving charge, or regaining custody of your kids, because he's your lawyer, but he's an exception. Think about the statement that people don't resent the businessman. Sure, they don't resent the local guy who they know who runs the corner store near their house and makes a good profit on their backs (selling milk at $5 for a bag). Put the same guy in charge of a national chain of convenience stores (selling Milk at $4.50 a bag) who they'll never meet and they'll resent the hell out of him, because he's one of Patrick's corporate fat-cats, screwing over the little guy.

As an aside, Steve about your comment that "if you are making $200k a year you cant buy a senator or even a congressperson. If you have a few billion in the bank?" Sure, but money doesn't vote. The most powerful political supporter in a particular constituency isn't the guy with a few billion dollars to throw around (even before Canada introduced tough campaign finance laws), it's the guy who can make a few phone calls and get a few hundred people out to a nomination meeting, swing a few delegates at a leadership convention or put together a fundraiser. That's not George Soros or the Kock brothers, it's the president of North Battleford chamber of commerce or the preacher of the local Baptist church. All politics are local. In most electoral districts, Billionaires usually aren't. That isn't to say that it isn't nice to get both George Soros and the preacher of the local Baptist church (or whatever) together on your side, but you can't get elected without the latter.

[hix]

Divine right, scin colour, gender, working harder, better genes, its all the same and a lottery winner class will find a way to claim they are richer because they are better too )-:.