In a couple of recent posts, I’ve been looking at returns to capital. First, there’s the fact that real returns on long-term (up to 30 year bonds) are now below zero in most countries. I argued that such a situation is inconsistent with the existence of capitalism in the traditional (say, pre-1970s) sense of the term. Then there’s the fact that the biggest contributor to corporate asset values is “intangibles” which is a polite word for monopoly.

An obvious question that arises is: if this is the case, why is the stock market doing so well, holding most of an already high valuation even as the pandemic raises the prospect of a long and deep recession? In one sense, there’s no puzzle at all here. Stocks generally yield higher returns than bonds (this is the “equity premium puzzle” on which I’ve written a lot), but if bonds are paying zero, then investors will be willing to buy stocks with a small (expected) positive return. That implies, for any given expectation of future returns, a higher share price. On this argument, the fact that sharemarket investors have done well in the last ten years or so doesn’t mean that they will do well in the future. Rather, at current stock prices, they will be taking more risk for less return than in the past.

All of this raises more questions about what is going on with corporations. Although corporate profits are increasing at the expense of wages, that masks growing inequality between firms. According to this study from 2017 (abstract over the fold). “Earnings of public firms have become more concentrated – the top 200 firms in profits earn as much as all [other] public firms combined.” Firms are also paying out more in dividends and share buybacks and investing less, implying once again that (at least as regards public markets) the scope for capital investments yielding positive returns has become more limited. I suspect (but haven’t yet got good evidence on this) that a growing share of corporate profits are being captured in privately-held firms (for example, those owned by private equity firms), where there is more scope for various kinds of arbitrage and rent-extraction.

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In a recent post, I pointed out that long-term (30 year) real interest rates on safe (AAA) bonds had fallen to zero, and suggested that this meant the end of capitalism, at least in the sense that the term was understood in classical economics. On the other hand, stock markets have been doing very well. So what is going on? This is a complicated story and I’m still working it out,
An important starting point is the fact that the most profitable companies, particularly tech companies, don’t have all that much in the way of capital assets compared to their market value. What they have is monopoly power, which has been increasing steadily over time. That benefits those who already own and control these firms, but it does not provide new investment opportunities.

I’ll start by looking at price-to-book ratios. Alphabet, which owns Google has a market value five times the book value of its assets https://www.macrotrends.net/stocks/charts/GOOG/alphabet/price-book The ratio is 15 for Microsoft and 21 for Apple. By contrast, for General Motors, the classic 20th century corporation, it’s just under 1.

For the corporate sector as a whole, the comparable measure is Tobin’s q ratio, which has been trending upwards since the late 1970s and is now near the all-time high reached during the dotcom bubble.

The value of companies like Apple, Google and Microsoft is made up primarily of “intangibles”. That term can cover all sorts of things, and is often taken to refer to some special aspect of the firm in question, such as accumulated R&D, tacit knowledge or ‘goodwill’ associated with brands.
R&D is at most a small part of the story. The leading tech companies spend $10 – 20 billion a year each on R&D https://spendmenot.com/top-rd-spenders/, a tiny fraction of market valuations of $1 trillion or more. And feelings towards most of these companies are the opposite of goodwill – more like resentful dependence in most cases.

A simpler explanation is that the main intangible asset held by these companies is monopoly power, arising from network effects, intellectual property, control over natural resources and good old-fashioned predatory conduct.

In this context, the crucial point about intangibles isn’t that they aren’t physical, it’s that they can’t be reproduced by anyone else. No one can sell a Windows or Apple operating system, even if they were willing to invest the effort required to reverse-engineer it. While there are competitors for the Google’s search engine (I recommend DuckDuckGo), there are huge barriers to entry, notably including the fact that the product is ‘free’ or rather supported by advertising for which all consumers pay whether they use Google or not.

There’s a complicated relationship here between the rise of monopoly and the development of the information economy in which the top tech firms operate. Information is the ultimate ‘non-rival’ good. Once generated by one person it can be shared with anyone else without diminishing in value. As the cost of communication has fallen, it’s become possible for everyone in the world to gain access to new information at essentially zero cost.
What this means is that there is very little relationship between the value of information and the ability of corporations to capture value from it. The protocols and languages that make the Internet possible are a public good, created by collaborative effort and made freely available. The information on the Internet is generated by households, business and governments using these protocols. Without these public goods, Google would be worthless. But because advertising can be attached to search results, ownership of a search engine is immensely profitable.

In turn, this means that traditional ideas about capital and investment are largely irrelevant in the information economy. More on this soon, I hope.

With everything going on, we at CT haven’t managed any posts for a few days, so I’m opening a thread for comments on any topic. I’ll try to get comments out of moderation reasonably promptly, but bear in mind that I’m in Australia, near the opposite time of day to most readers.

Below, a review essay on Jacob Hacker and Paul Pierson’s most recent book, “Let Them Eat Tweets: How the Right Rules in an Age of Extreme Inequality.” The essay tries to highlight and explain the political science arguments behind the book, and the kinds of political science research that would be needed to properly build out the agenda that the book implies. [click to continue…]

Ever since I wrote Work for All with Australian MP John Langmore back in 1994, I’ve been pushing the idea that a path to full employment requires an expansion of publicly provided services. For about the same length of time, Bill Mitchell (also an Australian economostO has been putting forward similar (but not identical) proposals. At some point in this process, Bill became one of the advocates of what’s called Modern Monetary Theory, which makes the point that taxes don’t (directly) “fund” public expenditure. Rather, they ensure that the total demand for goods and services (for consumption and investment) don’t exceed the productive capacity of the economy, thereby generating inflation.

This reframing raises the question: does a Job Guarantee require higher taxation? The answer, using MMT reasoning, is “Almost certainly, yes”.

“Cancel culture” has recently been in the news as a threat to free speech and open debate, most notably with the publication the other week of that open letter in Harpers. Cancelling is essentially a kind of crowdsourced attempt to boycott and ostracise individuals for their words or actions, sometimes including calls for them they be fired from their jobs or denied contracts and opportunities by media organisations. In the democratic space of social media this can sometimes tip over into unpleasant mobbing and sometimes bullying. But is “cancelling” people always wrong? Is the practice always an attack on the norms of free speech and open debate? Might cancelling some people be necessary to ensure others get the voice and platform to which they are entitled?

One objection to “cancellation” is that it chills open debate and makes people self-censor. But the problem with this critique is that some speech should be chilled and sometimes people ought to self-censor. A society that refuses to tolerate speech like David Starkey’s recent racist remarks about “damn blacks” and the slave trade is better for it, and it is a pity that Starkey didn’t think twice before uttering them. Now that he has come out with such language, he’s been cancelled, and rightly so.
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I received an email earlier today announcing a new book series, focussing on Politics, Philosophy and Economics (PPE). There has been a notable rise in the success of PPE – as can be seen from the multiplying numbers of PPE undergraduate and graduate programs and PPE scholarly activities in recent years. This series is a logical next step in the development of the multidisciplinary and interdisciplinary study of topics that are relevant to economics, politics and philosophy.

The new series, which will be published by Oxford University Press, has a website, five editors (Ryan Muldoon, Carmen Pavel, Geoff Sayre-McCord, Eric Schliesser and Itai Sher), and a long list of editorial advisors (and I’m honoured to be included there).

I’m not sure how long it will take them to publish the first book – given how slow academic publishing is, it might take a while – but in the meantime the editors welcome book proposals by scholars working in this area.

Although my book-in-progress is called The Economic Consequences of the Pandemic, a lot of it will deal with changes that were already underway, and have only been accelerated by the pandemic. This was also true of Keynes’ Economic Consequences of the Peace. The economic order destroyed by the Great War was already breaking down, as was discussed for example, in Dangerfield’s Strange Death of Liberal England.

Amid all the strange, alarming and exciting things that have happened lately, the fact that real long-term (30-year) interest rates have fallen below zero has been largely overlooked. Yet this is the end of capitalism, at least as it has traditionally been understood. Interest is the pure form of return to capital, excluding any return to monopoly power, corporate control, managerial skills or compensation for risk.

If there is no real return to capital, then then there is no capitalism. In case it isn’t obvious, I’ll make the point in subsequent posts that there is no reason to expect the system that replaces capitalism (I’ll call it plutocracy for the moment) to be an improvement.

But first let’s look at the real 30-year bond rate. The US Treasury is currently offering an inflation-protected 30 year bond at a rate of -0.3 per cent. That is, if you buy the bond at say, age 35, you can get your money back, less a 10 per cent reduction in real value, when you are 65. This rate has fallen from 2 per cent, when the bond was introduced in 2010, and started declining sharply in late 2018, before the pandemic, and while the Federal funds rate was rising.

In thinking about the future of the economic system, interest rates on 30-year bonds are much more significant than the ‘cash’ rates set by central banks, such as the Federal Funds rate, which have been at or near zero ever since the GFC, or the short-term market rates they influence. These rates aren’t critical in evaluating long-term investments.

The central idea of capitalism is, as the name implies, that of capital. Capital is accumulated through saving, then invested in machines, buildings and other capital assets to be used by workers in producing goods and services. Part of the value of those goods and services is paid out as wages, and the rest is returned to capital, as interest on loans and bonds or as profits for shareholders. Some of the return to capital is saved and reinvested, allowing growth to continue indefinitely. Workers, on this account, can become capitalists too, by saving and investing some of their wages. At a minimum, they should be able to save enough, while working, to finance a decent standard of living in retirement.

But what happens if there is no return to capital? The collapse of interest rates on government means that’s already true for anyone who wants a secure investment. And the situation isn’t any different for the two remaining AAA-rated corporate borrowers, Microsoft and Johnson and Johnson. Microsoft is currently offering a rate of 2.5 per cent on 30-year bonds, and has exchanged lots of outstanding debt for new bonds at that rate (paying a 40 per cent premium for higher-interest bonds). That’s a real return of 0.5 per cent if you assume that the Fed sticks to its current 2 per cent target and hits it on average. (There’s a lot more room for inflation to surprise on the upside, in my view). If you allow a 15 per cent risk that Microsoft will go bankrupt some time before 2050, the expected real return falls to zero.

To complete the picture of returns to capital, we need to look at stock markets and corporate profits. That’ll be the subject of another post.

Andrew Gelman has a post on the benefits of negative criticism, where he talks about the careful methodological demolitions he has done of others’ research that he has found to be slipshod.

if you want to go against the grain you have to work harder to convince people. My point is that this is the exact opposite of Cowen’s claim that following his advice—“Avoid criticizing other public intellectuals. In fact, avoid the negative as much as possible”—will “force you to keep on thinking harder.”

I’m in favor of a strong culture of criticism, but for a quite different reason: because serious criticism is probably the most valuable contribution we can make to the cognitive division of labour. There’s a possibly mistaken understanding of a truly excellent social science book behind this argument. [click to continue…]

This Paul Krugman column helped crystallize the weirdness of the ongoing economists versus epidemiologists spat, perhaps more accurately described as the ‘some economists, especially those with libertarian politics, versus epidemiologists spat.’ Different theories, in turn below the fold.
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I’ve been reading the latest (excellent as usual) book from Jacob Hacker and Paul Pierson, Let Them Eat Tweets: How the Right Rules in an Age of Extreme Inequality . The opening paras read

This is not a book about Donald Trump. Instead it is about an immense shift that preceded Trump’s rise, has profoundly shaped his political party and its priorities, and poses a threat to our democracy that is certain to outlast his presidency. That shift is the rise of plutocracy – government of, by, and for the rich

This passage reflects the conflict between two propositions that I (and lots of others, I think) have been grappling with
(1) The rise of Donald Trump represents a radical transformation of the Republican party and American conservatism
(2) Everything Trump has done is a continuation of long-established Republican policy and practices.

Here at CT, Corey has argued for a long time that (2) is correct, and that conservatives or, more properly, reactionaries have always been about preserving hierarchy and power. I find Corey’s argument convincing, but not enough to persuade me that (1) is wrong. Hacker and Pierson also broadly endorse (2). But much of their book is a comparison of the trajectory of the Republican Party with that of the German nationalists in the dying days of the Weimar Republic. The fact that such a comparison, until recently regarded as an automatic disqualification from serious argument (Godwin’s law) now seems entirely plausible, suggests that something really has changed.

In trying to find a way to understand this, I was struck by the idea that the concept of a phase transition (such as from liquid to gas, or dissolved solid to crystal) in physics and chemistry might be a useful metaphor. I didn’t get past high-school in science, so I may well use the metaphor inaccurately – I’m sure commenters will feel free to set me straight.

To develop the metaphor, think of the Eisenhower-era Republican party as a complicated mixture of many dissolved ingredients, in which the dominant element was the business establishment, and the Trump era party, as described by Hacker and Pierson as a crystallised mass of plutocratic economics, racism and all-round craziness. The development over the 60 years between the two has consisted of keeping the mixture simmering, while adding more and more appeals to racial animus and magical thinking (supply-side economics, climate denial, the Iraq war and so on). In this process various elements of the original mix have boiled off or precipitated out and discarded as dregs. Stretching the metaphor a bit, I’m thinking of boiling off as the process by which various groups (Blacks and Northeastern liberal Republicans in C20, liberaltarians more recently) have left the Republican coalition in response to its racism and know-nothingism. The dregs that have precipitated out are ideas that were supposed to be important to Republicans (free trade, scientific truth, classical liberalism, moral character and so on) that turned out not to matter at all.

Trump’s arrival is the catalyst seed crystal that produces the phase change. The final product of the reaction emerges in its crystallised form, and the remaining elements of the mixture are discarded.

As I’ve probably made clear, I have no knowledge of or interest in any other sport than cricket (well… there’s also softball, obviously). Professional cricket has now restarted in both the UK and in South Africa. In South Africa, yesterday, the first match opened to scenes of the entire playing and management personnel taking a knee in support of the Black Lives Matter movement. Here are some pictures:

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As with most really neat sayings, the original (with billions, instead of trillions) is misattributed, in this case to the late Senator Everett Dirksen, a conservative Republican who nonetheless helped to write the 1964 Civil Rights Act. The saying can be traced back to an unsigned New York Times article in 1938, which said ““Well, now, about this new budget. It’s a billion here and a billion there, and by and by it begins to mount up into money”. This in turn improved on earlier versions going back at least to 1917
US GDP today (Over $20 trillion) is around 250 times as high, in dollar terms, as it was in 1938, so replacing billions with trillions isn’t much of a stretch.

With that in mind, what should we think about the $2.4 trillion pandemic relief package, and the likelihood of huge demands for public expenditure stretching well into the future? And how much of this analysis is applicable to the world as a whole, where large scale government responses have been the norm rather than the exception.
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The first is thought is just this: Gina’s post about parents and teachers prompted me to notice that I never posted about the white paper that Jake Fay, Meira Levinson, Tatiana Geron, Allison Stevens and I wrote for the Safra Center for Ethics series on the pandemic. Here’s the abstract:

Along with the economy and health care system, schools are an essential third pillar in promoting community resilience and rebuilding communities’ physical, economic, emotional, social, and cultural health in the wake of the global COVID-19 pandemic. Schools serve as sites and sources of community resilience in five distinct ways: they distribute social welfare services, promote human development, care for children, provide stable employment, and strengthen democratic solidarity. Yet long-term physical school closures—along with impending budget cuts driven by cratering state and local economies and tax revenues—make it extremely difficult for schools to perform any of these roles. We recommend three steps for restoring schools’ capacities to support community resilience. First, state and district leaders should set metrics for achieving access and equity in each of the five roles that schools play, not just in academic achievement. Second, to establish these metrics, policymakers should develop or strengthen mechanisms to engage diverse community voices, as local community members often best understand the specific ways in which their own schools support or impede community resilience. Finally, Congress should allocate significant increases in federal funding to support public schools and districts for at least the next two years; these allocations should include strong supports for high-needs districts in particular.

The second thing is less a thought than a request for the economists.

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