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Average is over

Summary:
A while back, Tyler Cowen wrote a book entitled “Average is Over“. If my memory is correct, one idea was that technology would allow some people to become much more productive than others, and/or technology would make it easier to identify who has been more productive all along. I’d like to play with this idea using a simple model economy with one firm—a newspaper with 101 journalists. Let’s say the newspaper pays each journalist 0,000.  Yes, some journalists are better than others, but . . . well . . . who’s to say how productive each journalist is?  It’s simpler to just pay them all the same. Now assume an innovation called “substack” comes along, which makes it possible to identify the productivity of each journalist.  It turns out that one journalist is far

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A while back, Tyler Cowen wrote a book entitled “Average is Over“. If my memory is correct, one idea was that technology would allow some people to become much more productive than others, and/or technology would make it easier to identify who has been more productive all along. I’d like to play with this idea using a simple model economy with one firm—a newspaper with 101 journalists.

Let’s say the newspaper pays each journalist $100,000.  Yes, some journalists are better than others, but . . . well . . . who’s to say how productive each journalist is?  It’s simpler to just pay them all the same.

Now assume an innovation called “substack” comes along, which makes it possible to identify the productivity of each journalist.  It turns out that one journalist is far more productive than the others, and sets up his own company, which generates $1,100,000/year in revenue.  Since he’s still doing the same work as before, the total productivity of the journalism industry has not increased.  That means the remaining 100 journalists at the original firm must take a pay cut equal to the star’s pay increase—a $1,000,000 cut spread out over 100 journalists.  So their pay is cut to $90,000/year.  How should we think about this change?

One answer is that the society in this tiny economy becomes more unequal.  But let’s make the society a tad more realistic.  In addition to the 101 journalists, there are 20 poor people with no jobs, who live off private charity and public assistance programs.  How do they feel about the extra inequality produced by this “substack” invention?

If we assume that substack doesn’t impact total GDP, then the poor are likely to benefit if the total consumption of the 101 workers declines when society becomes more unequal.  And that seems likely to me.  The talented reporter will probably consume somewhat more, but the cut in consumption of the other 100 reporters is likely to be even larger, in aggregate.

If the consumption of the 101 working people declines, then one of two things could happen.  First some of that consumption might be directly transferred to the poor.  That might occur because the rich have a higher propensity to give to charity, or face higher marginal tax rates—giving the government more money to redistribute.  But in a sense the exact mechanism doesn’t matter, all that matters is whether the 101 working people consume less in aggregate.

A second possibility is that the lower consumption of working people leads to more investment.  At first glance that might not seem to help the poor.  In fact it does.  The poor sacrifice nothing to boost investment in this case, but gain from living in a more productive society for the same reason that you’d rather be a poor person in Switzerland than in Uzbekistan.  Even people with no jobs have a much higher living standard in rich countries than in poor countries.  One implication of this is that poor people with no jobs might be skeptical of socialist candidates who threaten to “kill the goose . . . “, and lean more toward “left neoliberals”, those who favor a highly productive market economy combined with redistribution to the poor.  And I’ve seen some polling results to support that claim.

If my hypothesis about inequality leading to less consumption by workers is accurate, you might also see substack putting downward pressure on interest rates.

I’m a proponent of the “rational expectations hypothesis”, which is often said to imply that the agents in the economy understand the underlying model.  (That’s not actually the implication of ratex, but let’s go with the idea for a moment.)  Since my toy model assumes that one journalist is especially talented, then he should understand what I am saying here.  In that case, he’d also be a “left-neoliberal”, for exactly the same reasons that the poor in this economy hold that perspective.  He would favor capitalism plus redistribution.  A big goose, with the golden eggs being redistributed.

You might argue that someone making $1,100,000/year should oppose redistribution.  But this journalist is likely to be an idealistic utilitarian.  Why else would someone that talented take a lousy journalism job paying $100,000/year when he could have worked on Wall Street?  No, money is not his primary motivation.  (In any case, even if he weren’t idealistic, there’d be no cost in pretending to be, and a big benefit.)

This post might seem rather abstract and unrealistic, but I’m quite serious about the ideas.  Bill Gates earned more than $100 billion from middle class consumers of Windows, and plans to redistribute almost all of that wealth to the world’s poor, as well as other charitable causes.

PS.  Substack might slightly boost total GDP, but that strengthens my argument in this post.

PPS.  Another implication of this post is that (nationalistic) progressives will huff and puff about the “obscene” profits earned by companies that rely on intellectual capital, but they won’t try to do anything to make the industry less profitable (before taxes.)  That’s because US companies dominate these industries at a global level.  The profits earned overseas on films like “Dune” can be taxed and redistributed to Americans.

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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