Feb 26, 2018

Brink Lindsey and Steve Teles on Wealth Inequality

There exists a relationship between rapid growth and inequality and here’s how to unrig the system.
David Beckworth Senior Research Fellow , Steve Teles, Brink Lindsey

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Lindsey Brink is the Vice President and Director of the Open Society Project at the Niskanen Center. Steve Teles is a Professor of Political Science at Johns Hopkins University and a Senior Fellow at the Niskanen Center. Brink and Steve join the ‘Macro Musings’ podcast to discuss their new book, ‘The Captured Economy: How the Powerful Enrich Themselves, Slow Down Growth, and Increase Inequality.'

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu

Beckworth: Brink and Steve, welcome to the show.

Lindsey: Thanks for having us.

Teles: Thanks for having us.

Beckworth: I'm glad to have you on. It's an interesting, sobering book. Let's begin by talking about the story behind it. How did you guys come together to write this book?

Teles: Well, Brink and I have known each other I think for a decade now, and we have been running a series of monthly dinners between liberals and libertarians. Those go back to when Brink was at the Cato Institute, and we thought it was a good idea, especially in increasingly polarized times, to bring people together from different ideological perspectives to talk. Brink had written a famous infamous article for The New Republic called Liberalterians, and I called him up after that and said, "I think I might be a liberalterian." We got together. We started having these dinners, I think over the course of that Brink and I kind of had a mind-meld as our own perspectives started to change.

Lindsey: It actually got subconsciously on parallel intellectual tracks. I think it was in 2015 that I was focused on the growth slowdown. Why is growth not doing as well in the 21st century as it did throughout the 20th and looking for policies that could turn that around and mindful of the polarized political situation looking for policies that could have intellectual buy-in at least from the left as well as the right. I was doing this as a paper for Cato.

Lindsey: Meanwhile, unbeknownst to me, Steve was writing a piece for National Affairs on inequality and saying, "If we're going to make any progress in policy responses to inequality in polarized Washington, find polices that have some buy-in on the right." Me starting with right of center focused on growth and Steve starting with left of center focused on equality, both thinking about breaking through partisan log-jams, came up with the kind of trans-partisan agenda that were basically the same, so it was a huge overlap between my pro growth agenda and his pro inequality agenda in these two things, and we thought, "Well, this is sort of a sign. We should write a book together."

Teles: Yeah, I think the other thing that was going on is ... This was just I think the aftermath of Piketty's Capital book coming out, and so that was partially in my mind was that ... I read the book and thought there was a lot useful in it, but I found the overall approach of treating inequality as a purely natural spontaneous market process unsatisfying to me. It seemed to me that there was a story there about the role of the state that was important.

Teles: Not only did I think his answer to the cause of the inequality spike in the last 30 years was problematic, but it also suggested something problematic about how to understand political economy and the role of the state both in, again, what Brink was more concerned about, about economic growth, and in what I was concerned about was the growth and inequality.

Lindsey: Yeah, and with Piketty it's this mammoth tome and there's no politics in it. It's just this deep structural R is greater than G. Therefore, capitalism is just in its DNA that it's going to wind up in extreme inequality whereas we focusing on living in Washington D.C. see that politics is very much relevant to the distribution of income.

Twin Melees Afflicting the US Economy: Slow Growth and High Inequality

Beckworth: Well, tell us your key arguments from the book.

Lindsey: We start motivated with the twin melees afflicting the US economy in the 21st century; slow growth and high inequality. Growth in terms of real GDP per capita, annual increases has been averaging about 1% in the 21st century. It averaged about 2% in the 20th century. That cut in half means that over the course of a normal lifespan if someone born in 2000 got to enjoy 20th century growth rates, by the time she's an old woman, the economy would be four times larger than it is. It would double twice. Whereas if it only grows at 1%, it would only double once.

Lindsey: Over the course of a lifespan we're talking about an economy twice as big as it would have been if we could maintain 20th century growth rates. And whether you want to leave all that money in the private sector, or whether you want to tax some of it and redistribute it, we can have those arguments, but having a lot more money to play with either way is certainly a plus, so the stakes are enormous. Meanwhile, the slowdown in growth understates the slowdown in income growth for most people because of the fact of inequality, and most of that income is skewed off to the top.

Lindsey: You put those two things together, slow growth, high inequality, you get declines in absolute mobility, declines in the percentage of people who are doing better than mom and dad did, and you get more pessimism about the future. Election night to 2016 only 30% of Americans told pollsters that they thought that their kids would be better off than them. You get that kind of pessimism. You get weird political acting out. There's a lot of motivation for us to write this book, big problems, and we see that both slow growth and high inequality they're complex phenomena. There's no monocausal explanation, but the role of government affirmatively making matters worse on both fronts is an underexplored facet of the problem that we wanted to shed light on.

Teles: Right, and I think it's important to recognize that we're not giving an account of 100% of either the growth or inequality phenomena. Brink wrote a previous book called Human Capitalism, which made the argument that the increasing importance of skills is a very important part of the story of increasing inequality. Also, we have the increasing scope of the market. Greater trade is inevitably going to be producing more inequality because the winners can win over a bigger scale. We know that.

Teles: But neither of those explanations, which is a standard economics profession explanations, can explain especially the scale and the pattern of inequality with the sectors that are getting wealthier or that in particular are not losing income, which is an equally important part of the story, don't match up exactly with either the skills or the scope of the market explanations.

Beckworth: Yeah. As you mentioned in the book, there's this understanding you've just highlighted that if we do have more inequality, we would expect there to be some rapid growth going with that. There's a trade-off, but we're not seeing either of those, right? We're seeing it absolute terms both the level of inequality going up and growth is declining.

Lindsey: We were taught by Arthur Okun this big trade-off between efficiency and equity. That when you have rapid growth, you're going to have an increase in the spread and dispersion of income. There's been enormous increase in inequality in China since 1980 because of an enormous increase in wealth in China. In those circumstances you see greater efficiency and greater inequality going hand-in-hand. If you're worried about one, then you're going to have a trade-off between one and the other.

Lindsey: Where we are these days is that both growth is slowing down and inequality is getting worse. That's a bleak state of affairs. On the other hand, the silver lining is we have the potential to enact policies that can save two birds with one stone as it were, that can simultaneously make our economy more efficient and more equitable. That's what we're aiming to do.

A Rigged System

Beckworth: A big part of the explanation, not all of it, is that the system's rigged. I mean, you have a chapter. I think it's called rigged. We're going to get into more detail of specific examples of this, but the idea is that the reason we have this bizarre outcome which you wouldn't normally expect to see is because the system is rigged.

Teles: Right. In economics, it's described as rent-seeking. Again, over the course of trying to explain this book, I think we can do it either long or short. We can either tell the story in standard economic terms in which you described this is rent-seeking, or you can describe this in more in the institutional economics where you can think of this as different ways to institutionally embed markets with different distributive consequences.

Teles: Either way, it doesn't actually matter substantively, but the basic argument is there's been a growth in these forms of regulation that have the simultaneous effect of limiting either innovation in production models or ways of organizing the firm, and that has the effect of redistributing upward, so in some cases that's protecting segments of the market where there could be opportunities both to destroy existing forms of wealth and to open up new ways of organizing that would be better for consumers.

Teles: You can think of all kinds of things. The healthcare sector is full of these where doctors are able to protect themselves against challengers, against new ways of organizing. That's a good example of that. But you see this all over the market. One of my favorite examples is car dealers. This is a crazy way to organize the market, the fact that everybody has to sell their cars through franchisees, that you can't have direct sales by GM or Ford. This was a particular problem in the aftermath of the financial crisis where the car companies were coming under, but they had all these relationships with franchisees they had to deal with.

Teles: This is the problem for new car companies. Tesla has faced this almost everywhere that it operates because they want to sell their cars directly in New Jersey, and other states have all these franchising laws. But the economy is full of this stuff, and it both limits new forms of growth or new ways of organizing markets, and it actually increases. Especially if we look at finance or IP, it actually is a source of new and increasing forms of artificial non-market produce wealth.

Lindsey: In 2016 in the election cycle we were confronted with these populist spasms both the Sanders campaign and the ultimately victorious Trump campaign and both buoyed by this sense in the public that the system is rigged. That was a bigger clause line for both campaigns. The impressionistic basis for that is sound. Most people feel like they're just barely trading water. They see folks at the top doing great.

Lindsey: When bad things happen, like the financial crisis, they go under and pay heavy price. The people at the top seem to figure out a way to exempt themselves from any consequences, so this combination of feeling like the rules aren't working very well for us, and they're working too well for the other guys, and there's this element of self-dealing is in the air. I think it's driving these perceptions, but not terribly surprisingly. Populist movements often misidentify the culprits. They sense that something is wrong, but they go after boogeymen rather than the real problems.

Lindsey: Bernie Sanders wants to make it all about campaign finance. If we just get the money out of politics, then we could have social democracy just like apparently we all want it. On the other hand, you've got Donald Trump blaming everything on foreigners, and Mexicans, and Muslim terrorists and on bad trade deals, so they have different scapegoats, but responding to a real sense of grievance and frustration, and so it is our goal to rescue that sense of grievance and frustration from being bait for demagogues and focus it on the real problems that are behind it.

Beckworth: They're sensing something's out there. They just can't identify properly what the causes, and that's part of the object of this book is to communicate this. That's the hard task we have is we have to explain the nuances of trade and immigration and say, "That's not the boogeyman. What the boogeyman is, is the system is rigged." That's just a much more nuance story to tell.

Teles: I mean, there's an army with pitchforks out there. We want to make sure they're pointing their pitchfork in the right direction. I think that's as much as intellectuals can do in their interaction with social movements or larger social forces. We can't sermon these armies, right? They're produced by other kind of forces, but at least sometimes we can direct them to the right thing to be pointing at.

Lindsey: In this moment it's just so easy to scream about the populist in charge right now and all the crazy things they're doing, but if that is the sole focus, then implicitly that is the status quo is fine. The only problem is these people, these bulls in the china shop. But the status quo isn't fine. My political response to this current moment, this completely negative and focused on the bad guys currently in charge, is an implicit complacent satisfaction with the status quo. The status quo is fine, the complainers are the problem, and so we want to get very much away from that. We don't think that's a good political response as well as just being inaccurate and say there is something to this populist frustration, and we want to direct it in the correct direction.

Teles: I consider myself a liberal Democrat, and I think one of the problems, certainly you see this in the Clinton campaign, was that Clinton could not speak any kind of language of populism in a moment when, again, this general sense that we're describing is clearly in an inchoate sense out there among the public. Politicians need to be able to speak to it.

Teles: Everything she had to say were about often perfectly good to my mind; welfare state programs that we should be putting in place to compensate for some of this increasing inequality. But it had nothing to say about the underlying problem in the economy that was producing this, the thing way down underneath the surface that's generating these problems that she's trying at the very top to tweak. I think this is one of the problems, especially with inequality, is there's no way that redistribution on its own can deal with the scale of inequality that's being produced by the economy now.

Teles: One of the arguments from a Democratic point of view you've got to have both. You have to deal with these pre-distribution sources of inequality, and you have to have a redistributive story. If you have just one or the other, you're also then not tapping into people's real sense that the original way that the deck is being shuffled is wrong.

Does Globalization Contribute to a Rigged System?

Beckworth: Okay. And we're going to get into specific examples in a minute, but I want to first give you some pushback on your key argument, ones that I've heard elsewhere and some that I've thought on. I want to begin first with a point that you raised yourself, and that is what percent of this angst can we attribute to this argument as opposed to globalization, technical change? I mean, if you could put a number ... Maybe you can't. But could you put a number like what percent of the change going on is due to the system being rigged versus just globalization and other factors?

Lindsey: I can't put a number on it. All I can say is qualitatively this is a significant component of the problem.

Beckworth: Okay. It's non-trivial.

Lindsey: Yes.

Beckworth: All right.

Teles: I mean, one thing is there's no dataset that aggregates all these forms or I think even could because there's often some legitimate not just measurement problems with definitional issues. One thing you can say is you can go through, say, the composition of the top 1%, you look at who's in there, and a very large of the people who are in there are in sectors that have pervasive regulatory rent-seeking that we associate with. Huge numbers in finance, and we go very closely through the story in finance to show that the scale of the financial sector is very closely related to multiple different forms of public policy: doctors, lawyers, entertainers.

Lindsey: But finance executives, doctors, and lawyers, just those three groups, that's 40% of the top 1%. They're all clear beneficiaries of government.

Beckworth: No, I'm very sympathetic. I just wanted to throw that out there. I think you raise a good point in your book that these forces actually play off each other, so globalization can reinforce the rigging and rigging can reinforce the globalization. You mention the winner-take-all aspect through the recent changes. Why don't you explain that to our listeners? What is this winner-take-all development, and how does the rigging enhance that?

Lindsey: Picture the old market for musical performance. In a pre-recording age you have just local performers operating at local markets, maybe touring a little bit. But there you have a very decentralized marketplace because nobody can perform for anything more than people within earshot. Then you get recording. That makes for much larger potential audiences, and so the recording stars that can now reach millions rather than hundreds or thousands are going to be a lot richer than the troubadours of the pre-recording age.

Lindsey: Then you push it up to the next level where we are now, and you have global music markets so that Taylor Swift isn't just popular in North America but in Europe and in Asia as well, and so she's tapping into billions of potential consumers. The people at the very top of the music game are going to be taking home gains. They're just huge compared to those of the past because the market is much bigger.

Beckworth: And a system when it's rigged enhances that.

Lindsey: Yeah. If then on top of that you slap the current copyright policy, then those gains that would have been considerable in the marketplace anyway are then amped-up by policy.

Teles: You were talking about globalization and trade. One of the stories that we tell in the book is the way that American copyright law then gets put into global trade agreements, so we're essentially able to export our intellectual property regime into the global market. And that's another example where there is something people ought to be angry about, about many of our trade agreements, but it's not the tariff levels, which is the thing that Donald Trump and other people complain about. It's all these things ... They're supposedly directed at non-trade barriers but are really ways to put American constraints on the market, which is exactly what copyright is, into international regimes, so it applies to Thailand, and China and lots of other places.

Beckworth: Okay. That's the first critic of your argument. I like what you've said. I think-

Lindsey: But it's important to be clear that we are not selling patent medicine that this is a cure.

Beckworth: No, and you're very clear in the book about that too. I think that's fair.

Lindsey: There are deep forces that are pushing towards slower growth. Just the aging workforce, the slowing of population growth, the plateauing of educational achievement. Those are big structural headwinds that even if we have a productivity growth miracle abetted by good policy change, it's not clear that that could completely compensate for all the negative factors. Likewise, there are strong forces pushing for big gains at the top, and those will continue even if they're not being improperly exaggerated by policy.

Beckworth: Yes, there would still be angst even in the absence of these issues that you raise in your book just like there was angst when the US economy was transforming from a farming agricultural system to more industrial. There's always transition pains. The other question I have, and again, this is not to undermine the book. I think it's a compliment, but the financial crisis itself. There's been some research done that shows after severe financial crisis people tend to go to extremes in their political views. There's a recent paper I believe in the European Economic Review that looked at 140 years cross country section and said you tend to get this experience that we have now, so I wonder to what extent some of that angst is simply the residual from the Great Recession. I know we're almost a decade out of it now, but any thoughts there?

Teles: Well, I think certainly not just the financial crisis, but the government's response to it I think produce some of the sense ... Not just you combine the bailouts over which we can have different opinions and whether they were good or bad idea or whether or not. Once you got to 2008, you didn't really have a lot of choice, and that's one thing we often talk about is some of these policies are necessary within one set of institutional ways to organize the market, but often they're within the context of a really bad institutional way to organize the market.

Teles: For example, we had this conversation around deposit insurance. Deposit insurance is not inherently awful, but it's something you need within, for example, a system of unit banking or whatever but so are bailouts. Bailouts are a predictable feature of the way we've organized the regulatory structure for banking in the United States. But people had a sense that there was huge bailout. People in New Canaan, Westport, all those places, more or less did okay.

Teles: But if you look at the system we did to deal with all the people whose housing equity got wiped out, I think that was a really understated role in a lot of this anger that's been boiling up is there's all these people still with negative equity. They went through personal bankruptcies. They knew people who went through all that. I think there was that combination that really created more this just underlying cynicism about the basic regulatory structure and who's in control of it and who it's actually serving. I don't think that explanation and the one we have in the book are necessarily mutually exclusive.

Lindsey: Right. The problems of finance are a big part of our book, but beyond that, even if there is a cyclical hangover of this deleveraging that occurs after a financial crisis based recession, we see rent-seeking regulatory capture and the deformations associated with that in areas completely outside of finance. We'll get to these areas, but what's going on in housing and land use regulation and the huge distortions in the geographic distribution of our population that are occurring as a result. That's just totally separate from finance and I think is a big driver of both slow growth and high inequality.

Lindsey: Likewise, this profusion of occupational licensing, this metastasis of it, totally separate from financial regulation and yet clearly is gumming up the works of the economy and doing so in a way that's good for people at the top.

Beckworth: No, I agree. I think it's complementary. Maybe, if anything, the crisis opened up that story. It was festering, it was growing and made it come to the surface.

Lindsey: I think that's correct.

Beckworth: I have to mention we had Jesse Eisinger on the show, and we had his book, The Chickenshit Club. I think that book is another data point that is-

Lindsey: We can say that word this week.

Teles: Exactly. Daddy said it’s okay.

Beckworth: But his book for listeners I'm sure if they listen to previous podcast ... That book focuses on the fact that there wasn't even major prosecutions during the financial crisis. More generally, corporations in general don't seek criminal prosecutions anymore. They settle out of court. One way to look at this is very much an advantage, an opportunity that big corporations have. They have the resources to settle out of court. There's no incentive for better behavior and this reinforces. One of the key points he makes in the book is there's no measure in place to change behavior when they take this approach, and I just think reinforces the message of your book.

Teles: One other way to think about it. This may seem an odd comparison, but if you know Aeschylus’ Oresteia, the story there is about the sources of war and ongoing conflict. It goes down to the absence of catharsis, the fact that nobody has an experience of seeing justice done in a way that feels satisfactory. They feel like they can move on without this lingering sense that somehow people who were advantaged by injustice got away with it.

Teles: I think that part of the story of the financial crisis is there is this popular absence of a sense that those who made it happen got their just deserts, so everybody can then move on. It's this ongoing festering sore underneath our polity that isn't always openly discussed. We're not always pointing to it, but people are aware just in the way I think in the way that the consequences of the Iraq War or this underlying festering source that end up coming up in all kinds of other places.

Lindsey: Yeah, I think financial crisis more than any other single event just crystallized this diffused sense that ordinary people are getting slammed and have a tough time of it.

Teles: It's not fair.

Lindsey: While people at the top seem to be through self-dealing getting along just fine.

Beckworth: They're insulated from...

Teles: I think the really important point is unless our political system ... And this is why I think the cases in the book, and there's some others beyond the cases in the book, are actually so vital is unless both for substantive reasons for people and economic growth but also this general sense of catharsis. Unless people get a sense that those people who got unjust gains or having some of them clawed away, that's going to continue to provide a source of mobilization for demagogues, and I think that's true here. It's true in other countries. Unless you can actually draw some of that poison out of the system by dealing with these things, things like Donald Trump are going to keep coming up.

Rent Seeking is Institutionalized Corruption

Beckworth: Okay. Well, let's move onto to your examples you give in the book. One of the first things you talk about are rents. Tell us what is a rent, and is a rent necessarily bad, is it good, and then what do we know about it recently?

Lindsey: Rent in its pure economic definition is morally ambiguous. You can have good rents and bad rents. We are using the term as it has developed in political economy in its moralized sense. That rents are excess gains going to factors of production, and rent-seeking is the effort to get excess gains not through serving your customers better but through taking resources from other people. It's just there's two ways to make money; create value or to take something from somebody else, and rent-seeking is the effort to profit through the political process rather than through customer satisfaction.

Teles: Right. I think the simple way to think about that is two ways that you can generate rents. One is you can get a subsidy. You can get actually directly from the political system some resources that increase your profits, or you can get a legal restriction on your competitors, which increases your profits. Again, in occupational licensing is a good example. Doctors incomes are higher because they're not facing competition from other practitioners, from nurse practitioners or other people who could be doing the same kinds of work at lower levels.

Teles: Lawyers often have that. You could imagine lots of things, but right now lawyers do and therefore they get higher incomes, but they're not facing competition from people who are perfectly capable of doing it like people who are overseeing your closing on your mortgage. Lots of people could do that. You could train somebody in a few months to do that job, but right now lawyers being paid a very large amount are the ones who sit there when you're actually doing your closing. That's a way to think about that. That's a rent that comes from constraints on competition, and there's rents that come directly from subsidies.

Beckworth: You mention in the book that the amount of rent-seeking is a measure of institutionalized corruption. Just speak to that.

Lindsey: It's a measure of both economic corruption and political corruption. Markets work best when producers face incentives so that they maximize their profits and income by best serving customers, by creating value for others. Whereas when rent-seeking is dominant, basically producers profit in a zero-sum or even negative sum fashion. Likewise, it's a species of political corruption.

Lindsey: Democracy works well when we take all the noisy signal of public opinion and filter it through institutions that produce policies that work well for everybody and that vindicate an advance broad public interest rather than privatizing public power to produce private gains. When rent-seeking is dominant that's what happens. Public power is misused and redirected for merely private gain. This problem is as old as politics and economics.

Lindsey:At the dawn of modern capitalism, Adam Smith wrote about that you never get two or three businessmen getting together, but they start talking about setting prices and divvying up markets. Likewise, at the dawn of our republic, James Madison was worried about the problem of faction, the problem of special interests that could take over and corrupt the political process, so these are perennial problems. But in our era we have seen them arise in a particular new configuration that is causing all kinds of problems and that we need to respond.

Teles: The other important way to think about this is that both the problem of inequality and the problems of economic growth are exacerbated by this, in part, through the reduction in creative destruction. That's one of the things that the existence of entirely new forms of economic organizations, entirely new ways to structure markets often destroys existing sources of wealth or concentrations of wealth. That's one of the countervailing forces that markets have against inequality.

Teles: When there's very large concentrations of wealth, that brings in competition, which can eventually push them away, in the process bring new things to consumers, so they don't have new forms of wealth. When you have this ability to constrain that creative destruction through markets, you both are going to exacerbate the problem of inequality, and you're going to be slowing many of the sources of economic growth.

Beckworth: Yes, and you come up with a list in your book of potential signs that rent-seeking is all-time high, and there is some debate about these measures, but collectively, they indicate something is going on. Where there's smoke, there's got to be some fire. I'm going to quickly list them up. Cooperate profits are way up. The distribution of the profits are also concentrated with the most profitable firms. There's a rise in Tobin's Q, which is a ratio of the replacement assets to the value of the cost of the assets, and it suggested intangible assets are up, which might be ties to government, which itself is something-

Lindsey: Could be part of it.

Beckworth:  Could be part of it. Also, there's increasing concentration you mention among industries. Finally, what you just mentioned, Steve, a decline in business dynamism. New business formation is down. It's circumstantial evidence, so they point to increased rent-seeking. Let's move on to specific examples, so let's begin with finance. Where do we see this in finance?

Lindsey: Financial regulation is a sprawling, enormous, incredibly complicated field. We delve into particular aspects of that. Not again trying to produce some sort of unified theory that explains everything that went wrong in financial regulation, but attempting to make the argument that regulatory subsidies are a big component of the current regulatory model, and that these subsidies work in a way that, A, makes the economy more volatile, more crisis prone, B, chronically misallocate capital, and C, we're down very much to the benefit of financial elites and exacerbate the gains that they are receiving.

Lindsey: In occupational licensing it's easy. The common law rules apply to everybody, and then there's this thing, this occupational licensing, that's sector-specific, or industry-specific, and it's this clear barrier to entry. Here in finance it's really hard to figure out what the laissez faire baseline of a free market financial sector would like against what you would compare this or that discrete interventions, so modern finance and the modern state coevolve together. They've been inextricably connected almost everywhere, almost all the time.

Lindsey: You've got a few decades in Scotland of free banking, and that's just about it. Here it's I think idle to try to identify discrete market failures or discrete government failures because we don't know pristine markets look like. What we can do is identify alternative regulatory systems, and the regulatory system we have today does a couple of things. First, it props up dependence on extreme leverage on very high levels of debt. Those high levels of debt make the financial system more volatile.

Lindsey: Just small declines in assets when you're highly leverage, just small declines in asset values can completely wipe you out, and we are in the precarious situation always in the financial sector. We could have a very different financial system where it's much more heavily financed with equity than with debt, but that's not what we have. Every time the system runs up against a wall and threatens to blow up, regulators step in to save the day.

Lindsey: It's a very deep institutional argument, but the whole regulatory design, assuming that extreme leverage is natural, unavoidable and even beneficent, we think is a huge component behind the excessive size of the financial sector. This financial sector is larger now because it's highly leveraged than it would be otherwise and explains its vulnerability one crisis after another.

Teles: Right. One way to think about this is ... And again, I think the point about there not being any free market baseline is a really important one and certainly is important conceptually for me. All you have are different institutional ways to embed a market at least in the financial case, right? But those different institutional structures for the market have effects on stability, on distribution, and on growth and economic dynamism. You can actually say, "Well, which of these institutional ways to organize the market is best able to simultaneously serve all these gains?"

Teles: It turns out we've designed one that increases the overall size of the financial market both through the mechanism that Brink is talking about. That is when you've got incentives for leverage, on a lot of leverage you're going to have an overall swell market, and we have huge forms of just straight up direct subsidy. The 401(k), 529s, all those things, all those ways we have for subsidized saving, which all actually disproportionately go into active management which can never actually produce gains for consumers just by definition. That's straight up subsidy.

Teles: That creates a very large army of active managers at the same time that we have the huge securitization that we have that is not a purely market spontaneous outcome. The government was deeply implicated in the growth of securitized mortgage finance, and securitized mortgage finance produces a very large pool of assets for bond traders to make money on trading. When you add up all these multiple forms of both regulation and the absence of regulation, again, that's where the absence of regulation, especially regulation of leverage, is implicated in the rest of the regulatory scheme.

Teles: But the point is the overall thing, all points, all the arrows point to incentive for a swelled and overly large financial sector, and that then filters down to growth because one thing that does is it pulls human capital that could be going into other areas, especially if you go to any elite university. In Johns Hopkins we had this. Lots of kids are all going to finance. They don't know why. They're going in because except the fact that there's lots of money in it, and there seems to be lots of jobs, and those financial firms are able to launder their high profits back into drawing and inducing that human capital into their sector and not going into other areas. That has effects on growth and dynamism.

Beckworth: They benefit, the economy loses. Alternatively, you hear this statement that the financial system will privatize all the gains, socialize all the losses in the event of a crisis. That's due to all these subsidies that you've been talking about.

Lindsey: Yeah. With the subsidies on leverage, that increases the risks and the returns. The upside is increasing the returns. During the good times you have higher gains than you otherwise would because you're highly leveraged, and you get to keep all of those. And when the time to pay the piper ultimately occurs, maybe it's 10 years after you've retired. You've banked all your gains, but whoever is sitting there when the game of musical chair stops, the government will be stepping in to absorb the downside. That just naturally by having a system that has a huge amplitude of gains and losses and the gains are all privatized and the losses are socialized, you just naturally go into….

A Silent Revolution in Intellectual Property

Beckworth: Yeah, and this goes back to what he said earlier that the financial crisis kind of brought this to a head, the Main Street versus the Wall Street. Unfairness, the angst maybe sharpened our focus on this particular development. All right. Let's move onto intellectual property. This is a really fascinating chapter because I see some of it in my own life. I'll explain why later. But you mention there's a silent revolution that has occurred in intellectual property, so why don't you tell us about that?

Lindsey: It's just been a huge increase in the scope of copyright and patent protection and the vigor with which these laws are enforced. On the scope side for copyrights, since the mid '70s expansion to unpublished material, so everything that's written now is copyrighted. When you forward a friend's email, you're violating copyright because you're doing an unauthorized replication of his email.

Lindsey: Meanwhile, the terms of copyright have expanded dramatically. It was 28 years plus one 28 year renewal. Now it's life of the author plus 70 years, an enormous stretch of time. Meanwhile, on the patent side, today every year the US Patent and Trademark Office has used about five times as many patents as it did back in 1980. Most of that is because of a general decline in the standards for patentability plus the opening up of patentability for whole new areas: software, business methods like the Amazon's one-click button, and even parts of the genome.

Lindsey: We've seen huge increase in intellectual property protection on the patent side with no corresponding increases in productivity growth or innovation, and that alone should be a head-scratcher, right? These are laws are supposed to be ... They're advertised as necessary foundations for artistic expression on the one hand and technological innovation on the other. But, in fact, we are in a period of depressed productivity growth, so what's going on?

Lindsey: It turns out that for sure copyright and patents they provide benefits by creating temporary monopolies, that they raise the gains for particular authors or particular inventors, so those people are incentivized to produce more. But they also impose costs, not just costs on consumers from higher prices from these temporary monopolies but also costs on downstream innovators. These days, like information technology, most new innovations are bringing together tons of different components into really complex devices, and if all of those components are subject to patent protection, then your access to the upstream ideas you need to make your downstream innovation gets blocked.

Lindsey: Ultimately, those costs downstream can outweigh the benefits upstream. It seems pretty clear that's where we are right now, especially with patents, with the rise of patent trolls, these entities that just exist to buy patent portfolios and weaponize them, use them to litigate and monetize. The majority of patented cases now are brought by these kinds of entities, so they're brought by people who make nothing against innovators. Almost all patent suits are not based on copying. They're based on independent invention but invention in second place.

Lindsey: What we're seeing is a whole realm of law that is sold to the public as this bulwark of our creativity and our technological inventiveness being turned around, captured by special interest in a way that is actually now sort of a minefield for innovators.

Teles: Right. I think one thing that's important to note in both of these cases is these are cases that, one, have very disproportionate organization. There is not any equilibrium between the two sides on this at least until recently. IP is an interesting one because the people who do benefit from sharing are starting to get organized, so Google benefits very substantially from sharing. It wants people to be able to share without being afraid of legal consequences.

Teles: But almost all the legal regime that we have for this system was set up prior to those very substantial beneficiaries from a more relaxed IP regime, so they have to all fight on a preexisting legal terrain that's very hard to change also because that legal terrain, for reasons we talked about before, got taken first into our national law and then imported into international law through international trade agreements. I don't think that was an accident. I think that was a conscious strategy to be able to lock in these things in national law because they're all part of larger international trade agreements

Teles: But the important point is that, A, these are very technical, so policymakers are going to be very highly reliant on those who can actually explain what's going on in these areas. It's going to be very easy for those who are organized. This is true in financial regulation and it's true in intellectual property that the complexity is in the service of those who are better organized because those who are better organized in complex fields like this are better able to subsidize information for policymakers, and so that's true in both finance and in IP.

Teles: And there's a sense among policymakers that this is the golden goose, and that gives an advantage to those who were benefited by these regulatory regimes because they can say, "Hey, look, this is where all the wealth in our economy is being produced, by finance, by entertainment, in software, in these other areas, so don't do anything. Just don't mess with it." That creates a very powerful bias towards the status quo.

Lindsey: A big status quo bias that's protected by these kind of sky is falling arguments. Make any changes in patent law whatsoever and all of the forces that support the status quo will run to Congress and scream that this will just be the death of American innovation. Likewise, any attempt to reduce access to implicit financial subsidies through higher capital requirements, through forcing banks and financial institutions to finance more with equity is immediately confronted with screams of, "If this happens, we're going to lose leadership. Everything will go to London or to another international financial market. Plus, nobody will ever be able to get a loan again," so coming up with these scare stories is just the stock-in-trade of lobbyists often.

Lindsey: And when you're a billionaire and representing a master of the universe or you're a tech founder and again have this obvious brain power and you're going up against a 20 something Congressional staffer who got his job through patronage, it's not a fair fight.

Teles: I think that's where, again, the political story here is important. The argument we make, at least making from the point of view of Libertarians, is maybe counterintuitive that many of these forms of government subsidy, protection are abetted by an absence of sufficient internal government capacity. That is you can imagine a system in which policymakers could be convinced that they need to get rid of some of these forms of government subsidy or protection, but precisely because there are these scare stories that those on the inside don't have sufficient expertise or experience to be able to assess, so if you had really highly skilled people who are in these jobs for a long time in Congress or in agencies, then they could say, "Look, I've been around here for 20 years. We hear these things all time. These aren't true, and I have all these deep relationships to expert communities that allows me to know that this is not the case."

Teles: That makes them a lot more less status quo bias, but a policymaker, as Brink said, who just got out of college, he's a legislative assistant to a congressman or he's working an agency his ability to really have the confidence to say that's bull is very limited. One of the arguments we make is if you want to get rid of some of these forms of subsidy or protection in the economy, you need to increase the internal capacity inside government to make and assess arguments.

Why are Legislators Listening to Lobbyists and not Think Tanks?

Beckworth: One thing that struck me as I read this part of your book it indicates that lobbying is very powerful, very effective, and I thought, "Where are the think tanks? Why aren't they providing a counterargument to that young staffer?"

Teles: Well, in our book we have two things. There's really two sources. That you need to get countervailing sources of information to those that are biased towards rent-seeking. One is inside of government. People need more internal capacity.

Beckworth: Standard capacity.

Teles: But also, you need subsidy for external capacity, so in the case of occupational license. People who want occupational licensing have every incentive to produce information showing that occupational licensing is awesome, but the incentive for those who are harmed ... This is basic Olsonian. This is one case where public choice does actually work pretty well. This explains why there's so little organization on the other side except for the fact that we have lots of stories in American history where that Olsonian trap gets solved by subsidy.

Teles: In the case of the environment, pollution is a form of rent-seeking. Maybe not in this building, but in lots of other places people consider pollution a form of rent-seeking. One thing that happened in the '60s and '70s is large foundations created countervailing power in the form of the Environmental Defense Fund, the NRDC. All these other forms of countervailing power help provide information to policymakers to help break into otherwise closed institutional venues.

Teles: The exact same story can be told about school choice. That's a story that's going to be more popular in this building, but you had teachers unions that were dominating the policymaking environment, dominating the information that was available to policymakers about what was in the public interest, and large foundations put a lot of money into it trying to equalize that organizational context in which those policies are made, and there's been lots of change as a consequence.

Teles: I think you really need some combination of both increasing the internal capacity that's available to policymakers, their internal ability to process information in a sophisticated way, and you need some form of third party subsidy to get over this basic Olsonian disequilibrium of organization.

Lindsey: For IP and finance, we talk about complexity being an aid to rent-seeking and also the policy image of the regulated industries. These people know what they're talking about. That helps. In occupational licensing and zoning we have the problem of just obscure decision-making venues, so little zoning boards in thousands of different communities aggregating up to decisions that are massively distorting where people live.

Lindsey: Likewise, occupational licensing, all of these licensing boards operating in total obscurity and meetings only attended by insiders. In both of these areas you have the problem of imbalance of flawed democratic decision-making where one side just isn't there. Here it's because the actual decision-makings are so obscure and so hard to reach that normal citizens have no incentives to participate, which is why this kind of third party subsidy form philanthropy can supply those volunteers that have a sense of, "This matters. The public interest is implicated here, and we are good citizens, patriotic citizens. We're helping our country be a better place by showing up at zoning boards and showing up at licensing boards."

Teles: That's a case where there is good evidence from work that Frank Baumgartner and has colleagues have done on lobbying and policy change that says that the real effect of organization is where you've got policies in which there's somebody organized on one side and there's nobody organized in the other. Even a little bit of organization can often have a very large effect on policy outcomes by providing some sense to policymakers that there's disagreement about what the public interest is.

Teles: And when there's only somebody organized on one side, when there's only somebody lobbying to licensed hair braiders or whatever it is and there's nobody showing up on the other, the easy outcome is for policymakers to say, "Yeah, that must be a good idea." Democracy demands disagreement. Conflict actually is the lifeblood of democracy. One of the things that we're talking about is many of these economic consequences we're talking about are coming about because of an absence of conflict.

Teles: Often citizens are saying, "Oh, the problem with democracy is there's too much conflict, and people aren't disagreeing enough." No, in many of these cases the problems is there's not enough conflict, but conflict is produced by organization, by mobilized citizens. That's where in some sense we have a more optimistic positive view of democracy than many people do in this book. The democracy can work when the sources of conflict and the things that produce conflict are present.

Lindsey: When the problem is there's obscure decision-making venues, one reform is to change the venue. In the zoning case we're seeing moves now in California to reassert state control over land use decisions because of the nationwide impact of these local zoning decisions, so moving where the decision-making occurs to an area where both sides are more likely to show up is often part of the solution.

Beckworth: Okay. Well, we have touched on the solutions. We didn't get to the specifics of zoning and occupational licensing, but we touched on those as well. Well, our guest today have been Brink Lindsey and Steve Teles. Gentlemen, thank you for coming on the show.

Lindsey: Thanks so much for having us.

Teles: Thanks for having us.

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