Ours the task eternal -- investing in human capital

That's the motto of Carleton University, where I work. Carleton's task, and my task, and the students' task, is to produce educated students. It takes a lot of resources to do this: my time, the students' time, the support staff's time, plus the use of buildings and land, and hydro. All those resources could be doing other useful things. There's an opportunity cost to educating students. Why do we do this?

Because we think the world will be a better place in future if we do this. And it's not just that the more productive students will get higher-paying jobs and more enjoyable jobs, though that's part of it. We think that it's better to understand things better, whether that thing is economics, chemistry, or literature. My blogging is itself part of that task, and if you are reading this you are a Carleton student, and part of our common task, whether you have a student number or not.

What do economists call it, when you do something that is costly today, because you think it will produce future benefits? We call it "investment". Investment is the creation of capital. Our task is to create capital. And that capital, in our case, is embodied in humans. Which is why it makes sense to call it "human capital".

Calling something "capital" says absolutely nothing about the legal system, and who owns it, and who has the right to do what with it. A bunch of educated anarchists has more human capital than a bunch of uneducated anarchists. "Capital" means the time structure of production, and any society that has undertaken present costs for future benefits has created capital.

"Human capital" is not a synonym for "labour". An uneducated worker who works for 10 hours does exactly the same amount of labour as an educated worker who works 10 hours. And it is not a synonym for the "skills" of that labour. Some skills we are born with, some we learn, and with most it's a bit of both; if you take a 5 year old Wayne Gretzky and a 5 year old me and put us through the same hockey camp, Gretzky is going to learn more skills than me.

It's funny how the words "human capital" upset people from both sides of the political spectrum.

Here's Greg Cochran, who thinks that by talking about "human capital" economists are saying that all individuals are identical in their abilities except for differences in education and training. I tried to explain that economists aren't that stupid.

And here's Paul Krugman, who I'm going to have to Fisk:

"Branko says that the essential difference between skills and physical capital is that the former aren’t worth anything unless you work, and that is certainly an essential difference."

Yes, owning skills is like owning physical capital that only you can operate. In both cases your labour and your capital are joint inputs. But my truck is still capital even if I'm the only person in the world who knows how to drive it, so it's worthless to anyone else unless I rent out my labour along with my truck.

"I would, however, also emphasize the flip side: if you think of capital as something that rentiers can own, which is surely one of the important things we connote when we use the c-word, then labor force skills are not capital in that sense. Children of the wealthy can inherit or buy factories and buildings; absent indentured servitude or the coming of androids, they can’t buy worker skills."

Well no. We should not think of capital as something rentiers can own. Capital is something that can exist, or not exist, independently of the legal system of property rights. Communist societies can have capital too. So can anarchist societies. The set of things that are capital, and the set of things that rentiers can own, are overlapping, but distinct. The "c-word" might as well be "canoes". Canoes are (usually) something that people can own; but that's not what makes them canoes.

And rentiers can and do own labour force skills, their own, and do collect rents from those skills. That's what my salary is (OK, plus a rent from my insider monopoly power). And if I lend someone money against his future earnings, I can earn rents from someone else's labour force skills. And if he promises to pay me a percentage of his future salary, I own a share in someone else's labour force skills. But it's a non-voting share, because I can't force him to work.

And the children of the wealthy can and do both inherit and buy labour force skills. Their own. Their parents pay for their education, which starts at birth. It's a costly investment in human capital to develop the potential skills they have inherited.

The concept of "human capital" is itself an investment in our human capital. It took an investment by economists from Adam Smith to Gary Becker to create that concept, and it helps us understand the world better. I am trying to prevent the depreciation of "human capital". Rust never sleeps. Ours the task eternal.

[Update: Noah Smith has a good metaphor for human capital, and a lovely(?) picture to illustrate that metaphor. I think he should have titled his post: "Humans aren't androids; we're cyborgs".]

Comments

[Kevin Donoghue]

Nick, I think you need to think a bit more about all this. You don't battle Elizabeth Bruenig on her own turf without more preparation. This, for example, is just sloppy: What do economists call it, when you do something that is costly today, because you think it will produce future benefits? We call it "investment".

On that definition, Operation Barbarossa was an investment.

[Nick Rowe]

Kevin: I'm not battling Elizabeth Bruenig. I'm battling that paragraph in Paul Krugman, which is wrong in many ways.

From the POV of the H man, Barbarossa was an investment, and one that failed badly. Investment is always uncertain, since it involves the future.

[Vladimir]

Why isn't human capital a form of consumption smoothing and capital simply the time structure of consumption? Second, you seized in your original post on the technical aspect of Milanovic's column. Fair enough but what I think he was trying to say is that ideas have real world consequences and as a student of inequality he found that the creation of human capital justified a certain distribution of income. Rather than think about income distribution as the product of how land, labour and capital interact , economists now attribute a large measure of outcomes to human capital. What's funny is you wrote a post comparing Friedman and Galbraith, you could say that Friedman won the macro arguments but Becker won the micro arguments with Galbraith. Think countervailing power v. human capital.

[Nick Rowe]

Vladimir: capital is closely related to consumption smoothing. Sometimes we invest in order to consumption smooth (like storing food for winter). But sometimes we invest despite it unsmoothing our consumption (low consumption today, so we can invest and have higher consumption in the future than today), and we won't want to do that unless there's a higher return than storage.

I never thought of the Becker vs Galbraith point. Hmmm. But yes, some people want to use the conceptual scheme of early 19th century economics. There's labourers with labour; capitalists with capital; and landlords with land. And the concept of human capital drives a dirty big truck right across their nice little model, so they don't like it. Plus, the functional distribution isn't the same as the personal distribution of income.

[Market Fiscalist]

In the light of the recent discussion about the S=I equality, it would be an interesting exercise to build a model of a service economy where human capital is the only form of capital. Resources spent developing and expanding human capital (schools , colleges, and on-the-job training) would be the only form of investment (and savings) in such an economy. I think you could still arrive at all the main elements of micro- and macro- economics using such a model.

[Nick Rowe]

MF: absolutely. Simplest way to do it would be to say that "I" represents the output of the educational sector. Not sure what other changes you would need; I think it depends on the model.

[Jared Harris]

Granting everything you say, there is still a big problem with scale. Wealthy people own enormously more physical / financial / IP capital than they could ever have as personal human capital. This is intrinsic to the current social arrangements -- we don't permit effective ownership of any aspect of another person.

This has strong policy implications. Wealthy people's incentive, in maximizing their return on assets they have or could trade into, is very heavily tilted toward maximizing the return to capital other than human capital. If anything they are incented to hold down the return to human capital since it is in competition with their slice of the pie.

So even accepting all your arguments, *functionally* there a huge difference between human capital and all the other kinds. Whether we should still call it human *capital* is a style issue, but we shouldn't let our choice of words confuse us about the underlying dynamics.

[Jared Harris]

There's also an odd style issue. I can say "I own my car". But it would be strange to say "I own my arm" (unless it was prosthetic). Similarly I find it strange to say "I own my system architecture skills". I can kind of understand calling skills capital even if they can't be traded (alienated) -- a factory in a trust might qualify, for example -- but shouldn't one at least be able to say one owns any capital assets?

[Nick Rowe]

Jared: "Granting everything you say, there is still a big problem with scale."

Good point. Investment in one's own human capital presumably runs into diminishing returns, because you can't or won't increase your own labour in proportion.

(Though I think there might be some sort of complementarity between owning human capital and owning other assets. "A fool and his money are soon parted" sort of thing. Learning how to manage your assets. Not sure.)

"I can say "I own my car". But it would be strange to say "I own my arm" (unless it was prosthetic)."

That might just be because we take it for granted.

[Jared Harris]

"Good point. Investment in one's own human capital presumably runs into diminishing returns, because you can't or won't increase your own labour in proportion."

Thanks. I suppose any specific form of capital runs into diminishing returns. But skills are also very limited in *how* you can invest in them, and the diminishing returns bite early and hard. For example if I want to ramp up production, instead of buying land, buildings, machines, contracts with suppliers, etc., I can just buy a company that already has them. This might actually be cheaper given opportunity costs, especially if I have the demand and they don't.

Conversely though there's no way I can spend money to become an expert in economics, Mandarin Chinese, or brain surgery in six months from a standing start. Plus, unlike buying a company, I can't delegate the work (if I want to *own* the skills) so acquiring skills at a maximum rate will also cost me nearly all my time until the acquisition is complete.

So I think "diminishing returns" is optimistic.

[Jared Harris]

"I think there might be some sort of complementarity between owning human capital and owning other assets."

I totally agree. But this doesn't indicate they are the same kind of factor -- if anything it suggests they are different factors.

It would be odd to say that undifferentiated capital is complementary to other undifferentiated capital. But once we differentiate, complementarity is natural: My warehouses are complementary to my delivery trucks.

So at a minimum to understand human and other capital being complementary we have to posit a major differentiation between two general factors of "production" even if we want to call both "capital".

[Jacques René Giguère]

It's not about the billionnaires that Barbara Ehrenreich wrote the book
Fear of falling: the inner life of the middle class.
http://www.amazon.ca/Fear-Falling-Inner-Middle-Class/dp/0060973331/ref=sr_1_3?s=books&ie=UTF8&qid=1424641262&sr=1-3&keywords=fear+of+falling

[Niveditas98 .]

Why is it so important to "own" capital? The trend in many industries if anything is towards not owning capital. Eg, neither of the two leading graphics chip companies own the capital necessary to manufacture their chips. Most of the parts that go into a GM car are probably not produced by GM, etc.

Why is hiring a semiconductor fab to manufacture your chips different from hiring a bunch of PhDs to design your chips?

"Wealthy people's incentive, in maximizing their return on assets they have or could trade into, is very heavily tilted toward maximizing the return to capital other than human capital. If anything they are incented to hold down the return to human capital since it is in competition with their slice of the pie."

But returns to skills are increasing, and they are regularly invoked as an explanation for rising inequality. This doesn't jive with the notion that there are strong pressures trying to hold down the returns to human capital.

[Roger Sparks]

I think of 'human capital' as a macroeconomic concept. It refers to education and training efforts of humans on a society wide basis. Clearly a macro area in my judgement.

This is not a denial that the term 'human capital'has a micro-economic component. In my mind, the term is the sum of all the individual efforts to improve their own skill levels. Does each individual have 'human capital'? I would say yes, each person has skills of some sort and can make a positive contribution to the economy, but each is contributing on the micro level, not the macro level.

BTW, capital of any kind does not need to be employed or deployed during any one time period in-order to exist. It is property available for use if the owner decides to deploy it.

Thanks for a well balanced post on the subject.

[Ryan Murphy]

"economists are saying that all individuals are identical in their abilities except for differences in education and training"

To be fair, the "strong" version of De Gustibus Non Est Disputandum, which is what Stigler and Becker actually meant, is not too distant from this statement. I mean, they explain the differences in the ability to appreciate classical music as a form of "capital."

[Nick Rowe]

Ryan: Hmmm. Fair point. But I would read that sort of thing as a methodological: "let's see how far we can push this thing and try to explain everything even though we know we're going to fail, because we can't tell how far we're going to get unless we try for 100%" sort of statement.

When econometricians use cross-section data to try to estimate the effect of human capital on earnings they know there's going to be individual-specific factors, both in the intercept and probably in the slope too. And that natural experiments where you get an exogenous increase in human capital (like raising the school leaving age) give you a better estimate of the effect of education on earnings, precisely because education will otherwise be correlated with those individual-specific factors so the estimate of Beta will be biased upwards. The whole signalling model of education is based on those individual-specific factors being correlated with education.

I expect there must be some economists somewhere who really are pure 100% Creationist blank slaters, but saying that investment in human capital matters doesn't mean you think it's the only thing that matters. But I would guess that most academic economists think that Darwin probably had a point.

[Kevin Donoghue]

Amusing to see Greg Cochran remark that Ashkenazim are "mostly believers in environmentalism, probably more than any other group you could name." I didn't expect him to admit that his views on intelligence hold so little sway, in an ethnic group noted for their intelligence.

[J.V. Dubois]

I just got into this discussion and I read several of the blogs. And now I will speculate but I have to address one elephant in the room because it saddens me that this may be (yet) another technically looking discussion that is is however politically motivated and therefore it will be hard to come to any meaningful conclusions.

I get it why some economists dealing with inequality may have problems with "human capital". But it is a problem only because they do not want to address real problems in their research for instance that young americans with high education debts are also among the poorest in the world in a similar vein why Jérôme Kerviel who made huge trading loss is probably the poorest man on earth. Scott Sumner who also does not like some assumptions in inequality discussion nailed it in this blopost: http://www.themoneyillusion.com/?p=24003 Summary, it seems that University town in Athens, Ohio is second poorest city in USA. Because it is full of students with lot of debt and low income.

So yes, if you are inequality economist with particular inclination it may be good to prepare for inevitable battle. So now it is time to rally all your supporters to create an environment where if somebody inevitably says "OK but what about HUMAN CAPITAL that all those supposedly poor students have" all the correct people on your side know exactly what to do by being primed to be sensitive to this nasty "Human Capital" term.

[Nick Rowe]

Kevin: yep ;-). He strikes me as being very smart and very knowledgeable. (His book with Harpending on the 10,000 year explosion was very good, AFAICT). But then it's always really hard to tell with people who are talking about something you know little about yourself. At least in this post, where I know he gets it a bit wrong, he admits up front he knows little about economics and human capital theory.

JV: that might be it. But I think that the inequality people who have the strongest dislike of "human capital" do so because they see the world through the lens of: poor labourers who own labour; rich capitalists who own capital; and rich landlords who own land. So the personal distribution of income is just a reflection of the functional distribution of income between wages, profits/interest, and rents. So "human capital" is something that (puts on Dalek voice) ***does not compute***, and must be a devious capitalist plot to obfuscate class distinctions and create false consciousness. And you can see why they are upset. "Human capital" drives a dirty big truck right across their nice neat distinctions. Plus some of them tend to think of "capital" as money, or financial assets, rather than the time-structure of production.

[Kevin Donoghue]

Nick, this is an awfully big topic so I mostly stay away from it. (Keynes once asked Edgeworth why he had never written a treatise; Edgeworth replied that large undertakings like marriage and treatises were not for him.) I'll just say that I think you'll get a better feeling for where "the inequality people" are coming from if you read Amartya Sen. Chapter 12 of Development As Freedom expresses some polite reservations about the notion of human capital and pushes the case for his preferred capability perspective.

[Nick Rowe]

Kevin: does that mean something like: "different people like learning different things, and like being skilled at different jobs, and like learning some skills more than others, so that human capital is subjective, and a consumer durable as much as a producer durable, so rich kids study art and literature while the poor kids take engineering and economics to get a job"? Sounds plausible. Sounds like a more sensible and interesting critique/modification of HCT. But that's not what I'm hearing in the current critiques and in the comments. It's workers vs capitalists.

[Oliver]

My knee-jerk reaction to the term 'human capital' (which I know nothing else about):

We think that it's better to understand things better, whether that thing is economics, chemistry, or literature.
...
What do economists call it, when you do something that is costly today, because you think it will produce future benefits?

First, you argue in moral terms, saying that we generally think it is 'better' to know more than less.

This says nothing about whether it will produce future benefits or not. It could just be better on its own terms. I could be arguing in my spare time...

You then say this knowledge constitutes a potential that can be employed in economic terms, i.e. for future benefit - I'm guessing preferably measurable in monetary terms?

None of the latter is necessarily implied in the former. Human capital is a sub-category of human knowledge. No unidirectional means-end deteminism as it is implied in the terms capital and investment can be derived from looking at human knowledge alone. Uncertainty only implies that the desired ends are not met, but for that they must first exist in the investor's mind.

So my beef would be that, if employed carelessly (which I'm not implying you did), the term human capital could end up reducing humanity to the logic of one particular strand of human thought.

I have no idea what Krugman or Cochrane are trying to say, though.

[Kevin Donoghue]

There's a lot more to it than that, Nick. An example may make just one of the crucial points in a concise way. The brightest guy in my class at school became an actuary and after some years working for a big company he set up his own business. He told me he started it with the notion that doing this would make him his own boss. He discovered that the opposite was the case: as he put it, when you are trying to build a client base, every one of them is your boss. You can't tell anyone that something else in your in-tray has higher priority. That guy's human capital is truly impressive, but you could seriously question whether he owns it.

Now when he retires with a substantial fortune, which I think he will, it will make rather more sense to say he has a healthy income from capital. Branko Milanovic would say that to treat his situation then as somehow analogous to his situation now is seriously misleading. Hence his view that the concept of human capital is flawed.

Sen would say that my old classmate is using his capability to obtain, in due course, what he really wants: freedom.

[Nick Rowe]

Oliver: "First, you argue in moral terms, saying that we generally think it is 'better' to know more than less."

Ah. That was supposed to be a descriptive statement about our beliefs. We think the investment in education will lead to future things that we think are benefits, either to us or to others, whether in money or not in money.

Kevin: from the sounds of it, his human capital stayed the same, but his labour became a lot less pleasant, when he switched jobs from employee to running his own company. (Not sure how a Marxist would handle that one, since he obviously switched from becoming a poor exploited worker to becoming a rich exploiting capitalist, crying crocodile tears ;-) )

[Kevin Donoghue]

Nick: I'm sure the Marxists who, whatever their faults, are certainly prodigious readers, have taken on board Galbraith's ideas about self-exploitation and how it shapes the attitudes of entrepreneurs:

The small entrepreneur is hailed as a man of rugged independence. That this independence is often circumscribed both in principle and in practice by a strenuous struggle for survival goes unmentioned. He is said, in contrast with the organization man, to be admirably unfettered in his political and social views. As just noted, these are likely, out of necessity, to be an uncompassionate reflection of self-interest. Living outside of organization, he is said to rejoice in freedom from the discipline of organization. No one gives him orders; no one supervises his work. He can look any man in the eye. It is not noted that this often the caution, conformity, obeisance, even servility, of a man whose livelihood is at the mercy of his customers. His is often the freedom of a man who is pecked to death by ducks.

[Nick Rowe]

Farmers are among the freeest. You can still sell your wheat and barley. I am less free as a prof than if I had stayed on the farm.

[Oliver]

OK, but it's still a 'do something now, get something later' concept. It could just as well stop at 'do something now'. Maybe our brains are just hard wired that way.

[Jacques René Giguère]

"Farmers are among the freeest. You can still sell your wheat and barley. I am less free as a prof than if I had stayed on the farm."

Those guys might beg to differ

http://www.reuters.com/article/2015/02/23/us-usa-grains-rents-insight-idUSKBN0LR0EX20150223?feedType=RSS&feedName=domesticNews

[Bob Smith]

Kevin: "He discovered that the opposite was the case: as he put it, when you are trying to build a client base, every one of them is your boss. You can't tell anyone that something else in your in-tray has higher priority. That guy's human capital is truly impressive, but you could seriously question whether he owns it."

But does the ability to dictate the terms of what you offer affect its character as "capital"? Isn't what you're describing true of lots of form of capital? If I a big pile of cash that I'm looking to lend, that's clearly capital in the old-fashioned sense of the word. But I'm also a price taker in a competitive market. If that means (as it does today) that I have to lend money at 1% (if I want a risk free return), well, that's what I gotta do.

The fact that a market might dictate the terms on which the owner of capital can offer his capital to the market doesn't detract from its character as capital. It's comment on the nature of the market governing the capital, rather than a comment on the character of an asset as capital or not.

[Bob Smith]

"But that's not what I'm hearing in the current critiques and in the comments. It's workers vs capitalists."

And I think it's that framework that makes the "inequality" theorists so uncomfortable.

I'm not entirely sure why. I would have thought that the usual marxist framework works just as well with a workers vs. capitalists vs. managers/skilled workers framework, with the latter, as the owners of the scarce factors of production, exploiting the other two. And, you can tell this story in a way that ties in with the dominant zeitgeist around inequality - i.e., corporate bigwigs are earning big bonuses while workers and small investors (through pension plans, etc.) get screwed.

I'm not sure the facts neccesarily back that story up (i.e., most of the 1% in Canada are various self-employed professionals, lawyers, accountants, doctors, etc. or small business owner/managers - i.e, traditional capitalists, but maybe the story is different in the US), but it's certainly not inconsistent with the prevailing views.

I guess the one problem with human capital, which may explain the discomfort, is that it undermines the implicit moral critique in the worker vs. capitalist framework. The workers are the source of all wealth while the capitalists are freeloading parisites getting fat on the backs of others. Granted, that's the labour theory of value and was discredited a century ago, but it retains a moral force in some circles.

The problem is that that moral critique loses a lot of force when it's the workers, or a least one subset of the workers (i.e., management/skilled labour) who are getting fat at the expense of the others (and especially when its the workers exploiting the capitalists). After all, the owner of human capital isn't sitting beside a pool in the Caymans cashing a dividend check every month, he or she is toiling away trying to invent a better Ipod or new financial instrument, performing brain surgery, etc. Moreover, the picture of Masters of the Universes (workers) spending their bonuses (employment income), when little old ladies (capitalist) are using the last remanents of their retirement savings (capital) to buy cat food, doesn't jive with the usual marxist analysis.

Describing human capital as a form of capital upsets the simple (and simplistic) moral framework afforded by the labour (good, exploited) vs. capitalist (bad, exploitative) mindset.

[Nick Rowe]

Bob: "I guess the one problem with human capital, which may explain the discomfort, is that it undermines the implicit moral critique in the worker vs. capitalist framework."

I think I agree.

I said once, in a comment on a lefty blog, that retired workers were (pension plan) capitalists. They were very uncomfortable with that idea, too.

[Kevin Donoghue]

Bob Smith: But does the ability to dictate the terms of what you offer affect its character as "capital"?

That depends on the kind of terms you can or cannot stipulate. I can't dictate the rent to a tenant; there are thousands of flats like mine in the neighbourhood. I can get the going rate, no more. My flat is capital if I choose to use it as such. Alternatively I can live in it. I see no objection to calling it capital in that case also.

But if the only way I can get a return on my flat is to convert it into a shop and run it myself, then it's not capital as it stands. Of course, if I actually carry out the conversion that's investment and the finished shop is capital.

My ability to scrub floors, find bugs in software, or write speeches for politicians is not capital.

Of course people are free to define their terms as they please. Nick is perilously close to saying just about everything desirable is capital. After all, his definition of investment includes military conquest. (See his response to my first comment.) I can't believe he's serious. On that basis the Highland Clearances were simply a portfolio adjustment.

Nick: I said once, in a comment on a lefty blog, that retired workers were (pension plan) capitalists. They were very uncomfortable with that idea, too.

So they should be. Retired workers (like me) are rentiers, not capitalists.

[rsj]

I like Noah's take on this. If you want to model something like paying for tuition as investment and the result of that payment an accumulation of human capital then you can do it. Mathematically there will be some problems because, on the one hand, this capital increases with labor use but on the other hand it disappears when you retire. There are limits on how much human capital you can accumulate but there are not limits on how much financial capital you can accumulate. One person can own 1000000 factories, but they cannot go to university for 1000000 years or be 1000000 more skilled than another. The rental rate on your human capital isn't going to go up with the interest rate. And you can keep stretching the analogy if you want, but you can't separate the term from the agenda, and other people may have different agendas.

[J.V. Dubois]

Maybe sidetracking current debate a little bit but I have a serious question. It concerns the nature of capital vs labor income itself, because to me when you really look deep down it seems quite arbitrary. I may use some examples:

1) Writing a book and then having share of profits: labor income or capital income?
2) Coding a new program and selling it: labor income from coding the software or capital income on my computer equipment or possibly on the software that I created that can be considered a capital in some sense?
3) Managing bunch of coders who create software that is sold: management labor income or capital income on software?

I could go on. For instance when Mark Zuckerberg created Facebook basically on his own with just a small team and heavily relied on his own work early on - and then later sold part of his work for billions of dollars can we say his income from share sales is just reflecting his unparalleled skill at coding/leading bunch of programmers coding social networks or is it somehow capital income where at some point in time his personal work stopped being superimportant to the project and he was basically just enjoying returns on capital he already created up to that point? What about profits he recieves from his shares - can it be considered something akin to novel author recieving delayed payment for his work or should we consider Facebook/Book as form of capital and profits stemming from it as capital income?

The point is that going deep enough, income always is combination of capital and labor. You may be creating something using your bare hands. You may also create stuff by your own labor using ever increasing complexity of tools/capital in your line of work. As part of your labor you may require fairly sophisticated inputs - up to a point where you may just work as portfolio manager using your intellectual labor judging which stock is better - or even going one level furhter and judging which people are better at judging which portfolios are better. In that case even having stock of shares and receiving returns from those can be somehow viewed as a result of amateurish portfolio management work similar to self-renting your own flat to you.

If you ask me it is a mess. Maybe it really requires some arbitrary judgment similar to the fact that for GDP accounting purposes cars bought by companies are considered investment while cars bought by noncompanies are considered consumption although they provide the same service.

[Nick Rowe]

Kevin: "Nick is perilously close to saying just about everything desirable is capital."

God no. And capital isn't really even a "thing". It's the time-structure of production. If there are current costs, and expected future benefits, it's a capital-theoretic decision. (And because time has more than 2 periods (it's not just this year and next year, but the year after that too, etc.), we can't always convert a vector into a scalar, which is where the Cambridge Capital Controversy comes in.)

"But if the only way I can get a return on my flat is to convert it into a shop and run it myself, then it's not capital as it stands. Of course, if I actually carry out the conversion that's investment and the finished shop is capital."

You lost me there. Why should it be capital if I did the conversion myself, but not if someone else did it for me?

"So they should be. Retired workers (like me) are rentiers, not capitalists."

I'm surprised you said that. I thought you were a young guy ;-)

I think there is something useful to the rentier/capitalist distinction, but it's a very fuzzy one. Holding non-voting shares makes you a rentier. A minority shareholder isn't much different, even if they are voting shares. But as you exercise more and more control, you are less and less a rentier, and more a manager of assets.

rsj: "The rental rate on your human capital isn't going to go up with the interest rate."

Does the rental rate on houses ($ per month per house) you up with the rate of interest? Only if higher interest rates reduce the number of houses built, which reduces the stock of houses, which increases rents. Same with human capital.

[Nick Rowe]

JV: Yep. Does capital income even exist? If I convert 100 apples into 105 bananas, do we say those 5 extra bananas are income? If I convert 100 apples this year into 105 apples next year, should we call those 5 extra apples income? They aren't the same good. We care about whether we are eating apples or bananas. We care about whether we are eating apples now or one year from now. They are dated goods. But denying the existence of capital income will really upset the lefties, much more than "human capital".

[rsj]

JV -- someone had to pay the programmers before facebook turned a profit. Someone had to buy the equipment, office space, etc. That person was an investor. The income received by the developers was labor income. You are being confused because in the case of self-funded ventures, it is your own wealth that is involved (you the investor are paying yourself the programmer). In that case, if the venture was profitable, you the investor receive an outsized gain (more than the risk free rate) whereas you the programmer just get the labor income. If you work for free, then you are investing your labor income. Many start ups hire programmers for below-market wages but in exchange for stock options and the distinction is pretty clear (e.g. the programmers are "buying" the stock options with the delta between the market rate and the wage they are paid). A wage of zero is just an extreme example of this.

Nick -- houses can be resold and are therefore bubbly, but based on fundamentals, the price of the house should fall so that the rental rate is the interest rate. That would certainly happen for a bond.

[Bob Smith]

Kevin: "But if the only way I can get a return on my flat is to convert it into a shop and run it myself, then it's not capital as it stands."

Really? So, is a specialized machine that is used, and can only be used, to make a Ford Escape, not "capital" because it can only be used by Ford? It can't be used and has no value to anyone else, but I don't think we would ever characterize it as anything other than a capital asset.

Kevin: "So they should be. Retired workers (like me) are rentiers, not capitalists."

I think that's a political distinction (made by people who don't want to lump their grandmothers into their capitalist=bad mentality), but I don't think it's a meaningful economic distinction. The rentier and the capitalist are the owners of the factors of production we characterize as capital.

In fact, in the modern context, that attempted distinction often falls apart completely. Whereas once upon a time the owners of capital was often the manager of capital, in the modern era, the managers of capital are typically highly paid workers- i.e., CEOs, etc. It's almost absurd to listen to the assorted post-marxists ranting about CEO salaries and executive compensation (i.e. labour income) as a sign of the evils of capitalism - apparently capitalism is when workers rip off the rentiers.

"After all, his definition of investment includes military conquest. (See his response to my first comment.) I can't believe he's serious. "

I think the problem is that you're making the (common) mistake of assigning a moral aspect to an economic concept (i.e., investment = good). Janice Gross Stein talked about this when she talked about the cult of efficiency (i.e., we often think of "efficiency" as a morally good thing, but there are clearly counter-examples - running an efficient death camp is clearly bad). But one can make "good" (in a moral sense, rather than meaning profitable) investments as readily as one can made "bad" (in a moral sense, rather than unprofitable) investments. If Dr Evil buys a laser to blackmail rich countries, that's clearly an investment in his blackmail business - it's still evil).

Just because military conquest could be considered an investment, doesn't make it good or bad. Hitler's invasion of the rest of Europe was clearly an investment by him in his dreams for a Germany empire. That it was evil (and failed) doesn't make it less of an investment. The military conquest of Nazi Germany or Imperial Japan by the United States and its Allies, on the other hand, was arguably (I'd say indisputably) a very good investment in the security of Europe and Asia - both in the moral sense and in the sense of being highly profitable. I think Nick's only point was that an investment is something that has costs now but earns a return in the future.

[Nick Rowe]

rsj: "Nick -- houses can be resold and are therefore bubbly, but based on fundamentals, the price of the house should fall so that the rental rate is the interest rate. That would certainly happen for a bond."

Yes. But notice there are two ways to define "the rental rate": rents per house, which has the units $ per year per square foot; and annual rent per dollar price of house, which has the units 1/years. The first is like a wage; the second is a rate of return. If we weren't allowed to buy and sell houses, so we could only rent them out, we wouldn't observe the price of houses, so wouldn't be able to talk about the rate of return on owning a house. Though we could talk about the rate of return on building a new house, or renovating an old house.

[J.V. Dubois]

rsj: Someone has to pay someone before anyone can make income. If you write a book somebody had to pay landlord of the in place you stay in and somebody had to pay people making your computer - even if that somebody is you. Does it make result of your work count as capital income? And if we are at that - when this hypothetical investor was choosing which company to invest in should this investor's income not be result his hard work of investing correctly where funds used for investment are just capital needed for this high-level work similarly as if novel writer needs some place to stay and computer to do his job properly?

Also the second point of yours when it comes to type of payment: wage vs stock options, can this legal issue make a difference if you still end up doing fundamentally the same thing? I don't think so. You are still going to code or do whatever you promised to do in exchange of whatever payment you agreed upon. But even if we admitted that there may be some merit going this direction the resulting discussion will still be ridden with fuzzy and unspecified things. For instance if part of your "wage" is tied to overall company profit does it make that part of your income a capital income? What about if if you recieve minimum cash wage and the rest is paid out as stock option? We could continue. As for wage vs other income what if hypothetically you stopped being core employee of the company and switched to being sub-contractor services as self-employed? Does it change your income from labor to capital although nothing substantial changed in what you do?

PS: also here I am talking about fundamental difference in labor income vs capital income. There may very well be some arbitrary tax-law based differentiaton and that is fine by me (at least for tax purposes). But I am afraid that when we have some philosophical/moral debate about labor vs capital income we have to go beyond this and all I see when we go there is a mess.

[Bob Smith]

JV,

I think you make the good point that you have look at what people are actually being paid for - what is the factor of production they're selling. If I'm the owner/manager of a business, the fact that my income is all dividends or all salary (which might be driven by tax considerations) doesn't take away from the fact that I'm actually supplying both capital and labour (usually).

I think that point also makes the distinction between labour and human capital more apparent. The fact that I'm paid more with a law degree than I was without one suggests that that excess is a return on my human capital, not on my labour per se. And activities like education have all the characteristics of other capital investments, i.e., they involve an outfront outlay (of money - capital - time, effort) and offer a potential (but risky) return. Indeed, I've joked elsewhere that university students would be done a great service if universities had to provide them with prospectus containing the same sort of information as is required for entrepreneurs offering securities to the public.

[Jacques René Giguère]

BobSmith: much of the 1% are professionnal and small business people : true but that's not where the action is. It's at the 0.1, 0.001 and 0.0001.
I talked with a friend, a car dealer. I told him how some people are too poor to buy Nissan Versa (I change the brand to preserve his identity inmy small town). Those who buy Versa should have boughr Sentra, the Sentra should have an Altima and the Altima shoud be driving Maxima. He understoood how hea 0.5%ter have been so totally robbed by the 0.001. To another one ,I showed him how his 17-chair hair salon should have been a 34-chairs. They have more in common with ordinary workers than the Masters of the Universe.

[J.V. Dubois]

Jacques: I will give you some counterexample. I know personally a really very rich guy. Yes, he lives in large house and has fleet of luxury cars but when it comes to it, his cars will do about the same job mine does in getting me to where I want. And when it comes to it and I really, really wanted that Ferrari I definitely could rent it for some time or even buy it if I was insane. Yes he may fly private jets or first class and stay in fancy hotels but when it comes to experiencing foreign countries there is not really that much of a difference, we still visit the same historical places, enjoy natural beauties etc. Plus there are things even money cannot buy. He uses the same iPad that I use, he watches the same movies that I can watch, I can read the same books, listen to same music and many more. Fundamentally our lives are not that different at some income level it is more about your time rather than anything else. In fact in most relevant characteristics I think that the difference between me and him is tiny compared to let's say a difference between me and somebody living in Kibera slum in Nairobi.

PS: Maybe there is some other apsect for "Masters of The Universe" - in terms of some really fancy stuff. I will never be able to go into space exploration like Elon Musk can, I will never do as much fighting malaria as Bill Gates does and I will not have ear of powerful people in government as finance magnates have - but neither does your cookie-cutter unimpressive heir/heiress to some billionaire empire. When it comes to this level I think it is more about personal influence, leadership and other qualities.

[Nick Rowe]

JV: "Yes, he lives in large house and has fleet of luxury cars but when it comes to it, his cars will do about the same job mine does in getting me to where I want."

True (approximately), but that argument cuts both ways, because it's an argument for rapidly diminishing marginal utility, and for saying he won't be hurt much by redistributing part of his income. (I still think we should give medals and honour with great ceremony those who pay the highest amount of taxes each year. We want some sort of status competition to get going, where cheating by overstating your income and overpaying your taxes is actively encouraged.)

[Bob Smith]

"BobSmith: much of the 1% are professionnal and small business people : true but that's not where the action is. It's at the 0.1, 0.001 and 0.0001."

And what percentage of the 0.1 percent or the 0.01% percent are employees (think CEOs, hockey players - there are 2500 of people in the top 0.01% of Canadian income earners, earning an average of $2.5M, a material proportion of them would be hockey players)? If people want to carp about the 0.1%, that's fine, just so they understand that they're complaining that the owners of labour (or at least a subset of the owners of labour) are ripping them off.

I'd also question the suggestion that the 0.00001% are somehow the cause of the "poverty" of everyone else. If Steve Jobs is a gazillionaire, it's because he invented products that we all want and think are well worth whatever we pay for them. Unless we're all deranged, he has made us better off, not worse off. Your friend the car's dealer's problem is not that Steve Jobs is taken money away from his clients, but that he's selling a product that people want more than cars.

[Kevin Donoghue]

Nick: If there are current costs, and expected future benefits, it's a capital-theoretic decision.

That makes buying green bananas a capital-theoretic decision, which illustrates my claim that you're close to saying just about everything desirable is capital. As for the conversion of a flat to a shop, it doesn't matter whether I do it myself or pay someone else to do it. Either way it's investment and the finished shop is capital.

Really, all I mean to say here is that I prefer definitions of investment and capital which are reasonably close to what a conventional economic statistician would accept. But if people want to follow Gary Becker's line and treat babies as consumer durables I can't stop them.

[kevin quinn]

Hi Nick. This is a little bit tangential, but I'll be brief. Calling education human capital implies that it is a pure means of increasing future income, that it has no value for its own sake, and that it is perfectly substitutable with any other asset having the same rate of return. Now Smith, who you enlist on your side, did not see education as (only) human capital. He thinks we need education to counteract the tendency of highly specialized labor to render people "as dull and stupid as it is possible for a human being to become." He doesn't see this as leading to greater productivity and higher income - otherwise, there would be no need, as there is a need, he thinks, for the state to require it. Further, he thinks that professionals and people of the middling ranks ought to be required to learn science and philosophy, not because it would improve their human capital - again, the provision of that sort of education, Smith thinks, can be safely left to the market - but because (in my favorite passage of the Wealth of Nations) "A knowledge of science and philosophy is the great antidote to the poison of enthusiasm and superstition."

[Nick Rowe]

Kevin: conventional economic statisticians do some weird things. According to Stats Can, if I buy a new car it's consumption. If a firm buys a new car and I rent it from them, it's investment. They do this for practical reasons (some stuff is hard to measure), but I don't want to follow them and twist my theoretical perspective to fit their practical reasons.

[Nick Rowe]

kevin: sometimes we distinguish between consumer durables and producer durables, but I'm not sure how important the distinction is. Stats Can treats houses as investment, but they are consumer durables. Education is consumer durable for some, and producer durable for others.

[YoungEcon]

I love the topic of growth, human capital and inequality. The one thing I can't understand is the hostility to the idea of human capital by those wanting to reduce inequality. There are some pretty good models that imply that redistribution would increase efficiency based on investment in human capital:

http://en.wikipedia.org/wiki/Galor-Zeira_model

The quick version: The marginal return to investment in human capital is higher than that of physical capital for a while, but then decreases below the return of physical capital. At some point you would be better investing in some machines than getting your 2nd or 3rd Ph.D. Therefore, at some point, the rich will start to invest in PC. However, the poor will have a hard time investing even in their own HC in a world with credit constraints (the important assumption).

Transferring some resources from the rich investing in PC to the poor so they can invest in HC capital may increase output. First, you get more output from the transfer since the marginal product of education is higher for HC than PC for low levels of investment in HC. However, there is a cost of the transfer, which is the disincentives resulting from the system of transferring resources from the rich to poor. If the former is greater than the latter you get more output by redistributing. E.g. taking a million dollars from Bill Gates investing in PC and using it to fund say 20 student's college education that they would not have gotten otherwise would increase output. (I think Bill Gate already gets this idea).

In the world of credit constraints the traditional trade off between efficiency and equity is not so clear cut.

[Jacques René Giguère]

Bob,Bob,Bob...Steve Jobs during the Ocuupy movement. Nobody cried harder than the occupiers. All of them recognized that, whatever his personnnal flaws, he had created lot of value, a minuscule portion he kept for himself, the rest being distributed in consumer surplus. Everybody got richer. Pure wealth creation.
Now, is Loth able to show the Lord a single hedge fund manager who a) created wealth b) in such a way that such wealth was distributed in the form of consumer surplus so that c) his death would be greeted with tears by almost every leftie on the planet? Try your best because otherwise, we so much !"/$%? because He is a Lord of Justice...

[Nick Rowe]

YoungEcon: nice clear concise intuitive explanation.

[Bob Smith]

Jacques,

Sure, hedge fund managers create consumer surplus for the consumers of their services - what, you think endowments and pension plans (and just play old wealthy people) pay 2 and 20 to hedge fund managers for shits and giggles?

You make billions building a better Ipad (in China) to sell to smelly hippies and you're a modern god. You make significantly less than billions building a better financial instrument or investment strategy to sell to pension plans, endowments and just plain old rich folk and you're the devil incarnate.

[Bob Smith]

Jacques,

Isn't it interesting that, when confronted with realities of the 1%, you start walking back what you really object to.

Down with the 1%.

Wait, they're all doctors and lawyers and dentists and self employed small businessmen (and university professors and senior civil servants, and judges, etc.), well, gee, they kinda deserve what's coming to them.

Down with 0.01%!

Wait, they're a bunch of hockey players and CEO, sticking it to their capitalist pig owners.

Down with the 0.000001%

Well, except Steve Jobs, 'cause I like his stuff. (Does that apply equally to Bill Gates, Frank Stronach? Granted Windows 8 and car parts aren't cool, but people seem to want to buy them? How about the Google boys? Jeff Bezos, the guy who founded Amazon? How about the Waltons? Larry Ellison? We're starting to run out of billionaires here)

Ok, Ok, down with the 0.000001%, but only the ones who are hedge fund managers because, boo, hiss, hedge funds.

At least we've got a rational basis for our prejudices.

[YoungEcon]

Nick thanks, but it is mostly cribed out of Weil's Economic Growth textbook. If I had to pick the best written undergraduate textbook on any subject in economics that I have come across it would probably be Weil's text.

[Nick Rowe]

Jacques Rene: Warren Buffett? (I don't know, I can't remember, but isn't he giving a load of cash to charity, along with Bill Gates?)