Re: Wealth, Innovation and "Job Creation"
Noah,
Thanks for the, as always, great post. You start by asking:
First, if it’s very uncertain how tax policy is going to affect innovation, why does that imply that taxes on the wealthy should be low?
I did not argue that that premise implies that conclusion. Krugman made an affirmative claim (or, as I went into in the post, he used language that Ozimek showed, I think correctly, could only be interpreted reasonably as implying) that innovators capture materially all of the economic value that they create. Ozimek provided a thought experiment that shows that this seems to violate common sense. Common sense is sometimes wrong, but I think the burden of proof is on those who make an affirmative claim. Krugman doesn’t provide any evidence for his claim beyond waving his hand at “textbook economics,” and Ozimek called him on it. I applauded this.
My only addition was to make an observation. Krugman claimed a contradiction between the belief in free-market principles and the belief that innovators can create material economic value that they do not capture, because the textbook economics that he believes is the foundation for belief in free market principles also claims that workers will capture the economic product of their labor. In fact, at least some people who hold free-market principles (e.g., me) do not ground their beliefs in Krugman’s textbook economics. So I am free to simultaneously hold the beliefs that innovators often cannot capture the full value of their work, and free markets are a good general organizing principle for the economy, without (at least this specific) contradiction.
Krugman claimed a contradiction between the belief in free-market principles and the belief that innovators can create material economic value that they do not capture, because the textbook economics that he believes is the foundation for belief in free market principles also claims that workers will capture the economic product of their labor.
“Surplus value” will do.
— Freddie · Nov 28, 11:13 PM · #
It’s not handwaving, and I’m wondering if you read Krugman as closely as you should have. Krugman says that this is true under a competitive economy and, by definition, it is. If innovators are capturing less than the value of their creation that’s collusion of employers (which is anti-competitive); if innovators are capturing more than the value of their creation that’s collusion by the innovators (which is also anti-competitive.)
Is it true in our economy? Who knows, but you should have understood that wasn’t the argument Krugman was making.
Well, no. You apparently don’t ground your principles in the belief that a “free market” is a competitive one, because that’s the only way to escape Krugman’s conclusion. A competitive economy is necessarily one where innovators – and all producers – capture as wage the full value of their contribution to GDP. Of course, given the full-throated conservative support for various forms of monopoly power and anti-competitive business activity.
— Chet · Nov 29, 01:00 AM · #
given the full-throated conservative support for various forms of monopoly power and anti-competitive business activity
As a conservative, I’m curious to know which sort of monopoly power and anti-competitive business activity I support full-throatedly.
— The Reticulator · Nov 29, 06:51 AM · #
I don’t see why this is even a debate.
1) Krugman’s certainly a believer in negative externalities. Why would there be a reason to doubt the existence of positive externalities?
2) OK, let’s grant Krugman’s point for the purposes of argument. Let’s assume that Steve Jobs and a few other innovators at Apple captured all of the new value created by the development of the iPhone.
2.1) Obviously, Krugman is not including consumer surplus in his analysis of what Jobs & a few other innovators are capturing. Most people who buy an iPhone are happier after the exchange than they would have been if they had not been able to buy it. It’s a rare person who gets charged the exact correct price at which they would be equally happy if they had made the purchase or had not. 2.2) Krugman is also ignoring the value that gets created through competition. The development of the iPhone leads to the Android market, notwithstanding Jobs’ reprehensible patent trolling. Eventually, the patents will run, and there will be even more value creation. As the market gets more competitive, more and more of this new GDP will accrue to consumers and workers. 2.3) Lastly, for a good Keynsian like Krugman, if Steve Jobs creates new value, then captures it all, aren’t we still better off. Let’s suppose Jobs creates half a billion dollars per year in Gross World Product, and personally captures all of that new value. So what? He’s going to spend most of it on something — either new investments, consumer goods, the construction of a stately manor, etc. If the only effect of Steve Jobs is to create a new billionaire in possession of a billion dollars worth of real product THAT WOULD NOT HAVE EXISTED WITHOUT HIM, then aren’t we better off for having him around, solely because he’s exchanging the product in his possession for other things?Conclusion: If I understand Krugman’s point correctly, he says it’s not really a big deal if a new tax reduces the number of innovations developed over the next 30 years, because the only people who benefit from innovations are the innovators themselves. IMHO, it seems pretty obvious that (a) people other than the innovators benefit immediately and (b) even if Krugman were right that innovators capture all of the value they create, we would still be better off for having this new value in the economy.
— J Mann · Nov 29, 04:07 PM · #
Jim:
I don’t think that’s an entirely accurate characterization of the argument between Krugman and Ozimek. Ozimek is the one who believes that in general people are paid the marginal value of their contribution to GDP:
His argument against Krugman is that “many high skilled, high paid workers, and job creators in the U.S. can be an important deviation from this general rule” – a general rule that he accepts as generally true.
Krugman, on the other hand, doesn’t say that he believes this is a good approximation of reality at all. He’s basically conceding for the sake of argument a point that (he believes) is part of his ideological opponents’ arsenal. That is to say: he doesn’t believe our economy is that competitive; he thinks there are all kinds of anti-competitive practices that benefit the already-wealthy. But, he believes, advocates of a maximally-free market think our economy either is or should be a close approximation of that competitive paradise. He’s arguing that if the economy were competitive in this fashion, then “textbook economics” would say that 100% of the marginal value of innovation is captured by the innovators, and that this implies that one argument often made against steeply progressive taxation is invalid on its own terms. The handwaving was all Krugman needed to do precisely because he presumed he was arguing from his opponents’ premises rather than his own.
And Ozimek basically says: yes, you’re right; my premises do, in general, imply your conclusion, but I think there are exceptions to the rules that I accept as generally true, and highly productive innovators are among those exceptions. So he rejects Krugman’s conclusion because he (Ozimek) finds an exception to his own premises.
Your point is that you have different premises for your conclusion that we should be biased in favor of low taxes and free markets that don’t include the premises of “textbook economics.” If I understand your position correctly, your major premise is very high uncertainty about the actual economic effects of any system of regulation or macro-economic management. Because of that uncertainty, we should prefer a system that is least dependent on such regulation and such management for its functioning, a system that is maximally self-governing.
My only question to you was: what does that have to do with the specific question of how progressive the tax system should be? If we don’t know what the economic consequences of a more or less progressive tax system would be, why should we prefer a less-progressive system?
If you do, indeed, think we should be biased against progressivity in the tax system on the grounds of your general skepticism about predictions regarding the economic effects of different policies, I’m curious to know the argument.
— Noah Millman · Nov 29, 05:07 PM · #
Why do you think Krugman does? It’s pretty clear, if you actually read his article, that he’s talking pretty specifically about an individual’s contribution to GDP, not to all the good they ever do in the universe. And again, it’s “textbook” true-by-definition that in a competitive economy an innovator captures as wage their entire contribution to GDP.
If you think you have some kind of counterexample, as Ozimek does, then you’re talking about one of two things – an economy that is not fully competitive, or a contribution by the innovator that is not a contribution to GDP.
Well, you don’t understand Krugman correctly. What he’s saying is, in a competitive economy innovators are paid no more and no less than their total contribution to GDP (that’s true by definition, because the economies where they are paid less or paid more are less competitive economies.) And someone who could innovate but doesn’t – for whatever reason – does not reduce GDP to any extent, because they would have taken as wage their entire contribution to GDP anyway.
Now, as it happens, we don’t have a fully competitive economy and innovators certainly do take as wage less than their contribution to GDP, probably far less, because companies collude to extract from them greater contributions to productivity than the wage they pay. But the Diamond-Saez calculation apparently attempts to take that into account. And proponents of free-markets – competitive markets – need to grapple with the fact that in their ideal competitive economy, there’s a much greater justification for high taxes on the rich simply because, in such an economy, nobody is actually creating anything but their own wage.
— Chet · Nov 29, 05:25 PM · #
The monopoly power of polluters, for instance.
— Chet · Nov 29, 05:29 PM · #
<i>And someone who could innovate but doesn’t – for whatever reason – does not reduce GDP to any extent, because they would have taken as wage their entire contribution to GDP anyway.</i>
But that’s not right. Pick any innovation, and let’s do the math. As an example, let’s suppose that due to my skill, if I personally run your power plant, you can get 10% more power with the same amount of fuel.
1) First, if a voluntary exchange isn’t anticipated to leave both parties better off, it won’t happen. So if I approach you and say “let me run your power plant. It will produce 10% more power, which I will then keep”, you would say no. Why should you agree to a deal that gets you a benefit of $0. Now my skill is unique, so I’ll probably get most of the surplus, but I won’t get all of it.
2) After that, we have to sell the power to consumers, who also get a benefit from the cheaper and/or more plentiful power. There’s no way that I can capture all of the consumer surplus on a real world sale.
3) Finally, even if I did capture all of the extra GDP I created, we’re still all better off. Unless I destroy that GDP or bury it in a hole, I’m going to trade with other people, who are benefited by those trades. If a Martian showed up tomorrow with a container ship full of a million iPads, it wouldn’t make sense to say “well, we can just blow up the ship without making ourselves poorer because it has ‘captured’ all of the iPads for itself.” The only way for the Martian to get use use out of a million iPads would be by exchanging them for stuff it wanted, which would make us all better off collectively.
(Note: Noah made point 3 in the previous post, which I hadn’t read. Mea culpa for stepping on your point, Noah).
— J Mann · Nov 29, 07:33 PM · #
Noah, I think you’re probably right, but it’s one of my gripes about Krugman’s style of rhetoric.
(1) It’s very hard to say for sure whether Krugman believes that high-value workers actually DO capture all the value they create or whether he merely thinks that his observation shows that free market critics should shut up and let him reorder the economy the way he wants.
(2) I don’t think it’s necessary that textbook free market economics requires the conclusion that Krugman asserts. Textbooks use simplified models to establish some core principles, but free marketers recognize that those are simplified models. In this case:
2.1) I don’t think it’s textbook that a high-value individual would capture all added value. If anything, it’s textbook that the counterparty wouldn’t enter the deal if there weren’t SOME value to the counterparty. 2.2) As I point out, consumer surplus is also in the textbook. In the real world, Steve Jobs doesn’t capture the entire value of the iPhone to every consumer. 2.3) I think Krugman’s stopping too early in the created value. Even if our hypothetical worker captures all of the added value to the entire economy of one extra hour of his work, it’s not true that the rest of us are no worse off if he declines to create that value. Once it exists, he will exchange it with others, for more mutually beneficial trades. Again, if I had plans to magically created 1 million iPads in my barn, it’s not true that just because I was the sole owner of those iPads, the rest of us would be no worse off if the government dissuaded me from doing that — once I had that wealth, I would trade it with others, to both of our benefit.— J Mann · Nov 29, 07:44 PM · #
Noah,
In my view, Krugman was not clear about whether he believes that to a close approximation people get back their marginal product of labor as comp. If he believes this, then I’d like to see some evidence beyond simply saying textbook economics. If he does not believe it, then a large fraction of his post was both wasted and poorly written, but his argument reduces to the one I addressed: that an intellectually honest person who accepts free market principles must accept that to a close approximation people get back their marginal product of labor as comp. For reasons I indicated, I don’t accept that one follows from the other.
You then ask me:
I don’t have a strong point of view on progressivity within broad limits. My view is that, as a general rule, with countless qualifications and exceptions, that taxes should be low, and think it is very hard to do that with 70% marginal rates. The reason I think taxes should be low is that high uncertainty demands trial-and-error learning, which inevitably threatens established interests, who inevitably use the government to restrain creative destruction. Therefore, the government should kept as small as possible, consistent with maintaining social cohesion, and a government which extracts a large fraction of wealth as taxes will inevitably become larger and more powerful.
This is said in highly summarized form appropriate to a comment string in a blog post. It is neither complete nor strictly defensible as it stands. I’ve just written a book to try to state it and defend it more comprehensively.
— Jim Manzi · Nov 29, 08:59 PM · #
And I intend to read your book as soon as I have the opportunity!
— Noah Millman · Nov 29, 09:18 PM · #
It’s exactly right. Suppose that extra 10% power results in $12,000 more of domestic product. You (the power plant) keep some of that and I get some as wage. If there are many power plants and only one of me, they all bid for my service, right up to the exact amount (minus one penny, perhaps) of additional product produced by my innovation. If there are fewer power plants, then they don’t need to bid as much, but that economy has less competition (by definition.)
We’re not talking about the real world, we’re talking about a fully competitive economy.
— Chet · Nov 30, 02:57 AM · #
—There’s no way that I can capture all of the consumer surplus on a real world sale.
We’re not talking about the real world, we’re talking about a fully competitive economy.
1) I don’t think we are. Krugman is making a point about the tax rates we should have in the actual world we live in. The question is whether discouraging people from doing more work would make us poorer, and Krugman is arguing, at a minimum, that free market economists are required to believe that it doesn’t. Free market economists believe that we live in the real world, so I think at a minimum, Krugman has to start from what free market economists believe about the actual world in which we are imposing taxes, not about simplified models that cannot pay taxes because they are not real.
2) Even a perfectly competitive economy has consumer surplus, unless you assume away transaction costs and asymmetric information. If I charge more or less the same price for an iPod and some people want it more than others, then some purchasers are going to enjoy their iPods more than others. The only way to try to capture all of that surplus is to charge each person the maximum they will pay. Used car dealers and US colleges attempt to do this by extensive negotiations or elaborate financial aid formulas, but even they don’t eliminate consumer surplus because (a) they don’t have infinite time to negotiate; (b) they don’t actually know what the maximum price you would pay for a used car or a Harvard education; and © if they used up ALL consumer surplus, so the consumer was equally happy getting the car or not getting it, why would anyone bother to buy one?
— J Mann · Nov 30, 03:44 PM · #
Then that can only be because you didn’t read the Krugman post:
Krugman’s been clear from the outset what kind of economy he’s talking about – an ideal competitive one. If your refutation of his argument involves any other sort of economy then you’re just moving the goalposts.
In an ideal competitive economy, there’s no such thing as a “consumer surplus” or any other sort of surplus, because producers are paid exactly the sum total of their contribution to product. Any more and the economy is less competitive (in favor of producers); any less and the economy is less competitive (in favor of consumers.)
Yes, but not the ideal real world. Krugman is simply making a logically inescapable true-by-definition argument from the economy the free-marketeers say they desire to have.
That’s exactly what “fully competitive” means, by definition – no deadweight transaction costs and no information asymmetry.
— Chet · Nov 30, 04:41 PM · #
“Krugman’s been clear from the outset what kind of economy he’s talking about – an ideal competitive one.”
Since such an economy is a complete impossibility, I’m not sure clarity is Krugman’s friend in this matter.
Mike
— MBunge · Nov 30, 04:53 PM · #
I don’t see how that matters. It’s a simplifying assumption – like a frictionless pulley or a massless rope. Certainly its not out of the blue for an economist to make simplifying assumptions to model the result of a change on the economy. The operating principle here is “close enough.”
— Chet · Nov 30, 05:48 PM · #
Thanks, Chet, I appreciate the correction. I didn’t realize that fully competitive was the same thing as perfect competition, and I’m glad for the chance to learn.
Serious question then: What do you think Krugman’s point is with the fully competitive analysis? I think his general point is that we should tax high earners more, but why is the alleged behavior of high earners in a theoretical environment relevant, when we know that the environment does not exist?
I mean, if they were working remotely from Venus, taxing high earners more would not reduce GPP because the high earners would all be dead, but I’m not sure how that’s relevant to their behavior on Earth.
— J Mann · Nov 30, 05:56 PM · #
See the comment immediately preceding yours, about “simplifying assumptions.”
— Chet · Nov 30, 06:35 PM · #
“I don’t see how that matters. It’s a simplifying assumption”
I no expert, but I think we’ve just had a pretty good demonstration of the effect “simplifying assumptions” can have on an economy. I believe the Maestro himself acknowledged that his “simplifying assumptions” turned out to be spectacularly and devastatingly wrong.
Mike
— MBunge · Nov 30, 06:59 PM · #
Well, the next time Krugman destroys the global economy with a single blog post, you can tell me “I told you so, asshole.”
— Chet · Dec 1, 12:58 AM · #
Innovations only take place within a broad framework that permits their realization, i. e. the transition from a napkin sketch to something like Facebook or an iPad. First, real innovation requires a broad base of strong theoretical knowledge, which innovators, no less creative or important, produce from basic research. Then, they require recognized standards, an existing infrastructure, and finally a working society. In practice, this means new innovations tend to both depend on and enhance older innovations, and stakeholders in those older innovations, from incumbent industries to consumers, inevitably derive a benefit. But innovation depends no less on the facilities, from security to dispute resolution, provided by governments. Therefore, it makes logical sense for innovators, along with the rest of us, to pay for the government required for a viable society. Jim Manzi and I probably have quite different ideas and instincts about what the government necessary for a viable society looks like, but that argument concerns the size, scope and function of government, not the effect paying for it has on innovators.
I also reiterate my previous points: on average, about half the computer innovations we use come from the work of people who neither sought nor obtained monetary rewards remotely in line with their contributions, so we cannot assume the tax rate will have an effect on the pace of innovations at all. Also, innovators intent of extracting the greatest possible financial value from their contributions tend to behave in ways that obstruct future innovations.
— John Spragge · Dec 1, 01:42 PM · #
“Well, the next time Krugman destroys the global economy with a single blog post, you can tell me “I told you so, asshole.””
And maybe if somebody had had the balls to get in the face of Greenspan and the like BEFORE they weasled their way into positions of authority, we wouldn’t be in this mess in the first place. For example, I’m not sure that Krugman understands that one of the major problems in our economic discourse is that he defines the leftmost edge of the debate. No one more liberal or progressive than Krugman is really allowed to take part in the discussion, let alone be seriously considered. Since Krugman is largely happy with the status quo and just wants smarter people in charge to run it better, more fundamental criticisms of national and global economic structure are almost completely ignored.
Mike
— MBunge · Dec 1, 04:27 PM · #