What happens when we run out of investment opportunities?

Throughout the 19th and 20th Centuries, the world had far more investment opportunities than we had capital available to invest. With the population growing, there was always demand to borrow money to build more homes, offices, and stores. And with a steady stream of new inventions — railroads, telegraphs, automobiles, refrigerators, televisions, cell phones, and so forth — there were always plenty of opportunities to build new factories, to make productivity-enhancing upgrades to existing factories, and to do research and development to advance the state of the art.

But what if that came to an end? Obviously, we’re never going to reach a point where there’s no investment opportunities at all. There will always be some people wanting to build a new house or start a new business. But the pool of available capital keeps getting bigger and bigger, while population growth is slowing and many recent inventions are not as capital intensive as those in previous generations. We could reach a point where there are no more investment opportunities at the margin.

If we lived in that world, we’d see inflation-adjusted interest rates around the world falling to zero. We’d see cash and short-term investments piling up on corporate balance sheets. We’d see the CEOs of even America’s most innovative companies deciding they have nothing better to do with this cash than to give it shareholders through buybacks and dividends. And we’d see the few companies that do seem to offer the possibility for significant returns earning ridiculously high valuations as too much venture capital chases too few startups.

In other words, a world with too much capital and too few investment opportunities would look a lot like the world we’re in right now.

During the 19th and 20th centuries, interest rates served two important functions. One function was to reward and encourage frugality. If you spent less than you earned, you could put the difference in a savings account and earn a risk-free return higher than the rate of inflation. The money would be leant out to others who wanted to build a house, start a business, or otherwise make a productive investment that grew the economic pie, and you got a share of the gains.

The second, more subtle, function of interest rates was to prevent severe recessions. A healthy economy relies on a steady rate of spending, which requires that people, on average, not hold on to cash for too long. If a lot of people pile up savings that don’t get re-invested, the result will be a reduced rate of spending, a.k.a. a recession. This is why the Fed lowers interest rates during recessions — it’s a market mechanism that encourages savers to save less (and hence spend more) and borrowers to borrow more (and hence spend more).

If society has run out of productive investment opportunities at the margin, then frugality will no longer be socially beneficial (though of course it might be beneficial to the person doing the savings). More savings won’t produce faster growth, and so there’s no reason for society as a whole to encourage people to be frugal. An interest rate at or below the inflation rate is a market signal that society has enough capital, doesn’t need any more, and so won’t be rewarding people who accumulate savings.

The second function of interest rates poses a larger problem when interest rates fall to zero. Remember, recessions happen when spending slows because people are accumulating savings that doesn’t get re-invested in houses, factories, and so forth. When interest rates are positive, then interest rates can fall to encourage less saving and more investing. But when interest rates have fallen to zero, this doesn’t work any more, because it’s safer and easier to just hold onto the money. Central banks have tried to address this issue by flooding the market with more and more cash. But it’s been difficult to get the money to circulate — it just keeps piling up in peoples’ bank accounts.

The problem here isn’t that people are saving too much, it’s that they’re doing their savings in cash rather than by investing in assets like stocks or bonds. This wasn’t an issue in the past because banks would automatically invest the money on their customers’ behalf. But now banks are failing to do that, and so money customers save in bank accounts gets effectively pulled out of circulation.

Another way of looking at this is that we want people to use cash primarily as a medium of exchange rather than a store of value, so it’s important that cash have a lower rate of return than other investments. In the past, non-cash investments tended to have a significant positive rate of return, and so the fact that cash had a rate of return of 0 was plenty of incentive not to hoard cash.

If we can’t raise the rate of return on non-cash investments, then the alternative is to lower the rate of return on cash. The Fed already does this by setting a 2 percent inflation target — essentially that’s a 2 percent penalty for holding cash. In an era where inflation-adjusted interest rates were almost always positive, that was viewed as an ample disincentive for cash-hoarding.

But in a new era of ultra-low interest rates, it’s apparently not enough. So one solution would be for central banks to raise the cash-hoarding penalty — that is, its inflation rate target — perhaps to 4 percent. Then even if non-cash investments don’t produce a positive return in inflation-adjusted terms, there will still be a significant spread between the returns on cash and on other assets. That will discourage people from holding a lot of money in the form of cash, making it easier to prevent major recessions.

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Conventional wisdom says the Fed can’t boost growth any more. I don’t believe it.

One of the big questions about the economy right now is whether monetary policy is a significant factor in the sluggish growth of the last five years. Lots of economists think that easy money was important for speeding the recovery between 2008 and 2010. But even some economists who believe monetary policy mattered in the early post-2008 years think that monetary policy can’t explain the sluggish growth we’ve seen more recently.

To quote the always-insightful Eli Dourado: “Monetary policy is important for 18 months or so after a nominal shock w/ an otherwise functioning financial system. That’s it.” Alex Tabarrok, co-author of the popular Marginal Revolution blog, recently told me it’s “crazy” to think monetary policy could explain the slow growth we’ve seen in the last few years.

I’m not so sure.

There are two major arguments that monetary policy can’t explain the recent slowdown. First, monetary policy is about as loose as it can be, so there isn’t room for the Fed to do more. And second, even if the Fed could do more, it wouldn’t do any good because with unemployment at 4.9 percent there isn’t any slack left in the economy.

As we’ll see, neither of these claims is very persuasive.

The Fed’s itchy trigger finger is holding back the recovery

After a big demand shock like the 2008 financial crisis, output temporarily falls below the economy’s long-term potential. Workers are laid off, factories get idled, construction projects are slowed down, causing the economy to produce goods and services at less than its full capacity.

But the conventional view holds that this shortfall shouldn’t persist for all that long. Businesses want to increase output. Workers want to work. And so unless there are further shocks, the argument goes, output should return to potential within 18 months or so.

Now imagine it’s 2009 and we have a diabolical Fed chair who wants to prove this conventional view of monetary policy wrong. Her strategy: every time the economy shows signs of catch-up growth — growing faster than the long-term trend to close the output gap — she tightens just enough to prevent that extra growth from occurring. Contrariwise, if the economy looks like it’s tipping into a recession, she eases enough to keep the economy growing, albeit at a sluggish pace.

If you think a sufficiently tight monetary policy can produce a big downturn in real output — and most economists do — then it stands to reason that less-tight monetary policy should be able to produce slow but positive growth. So theoretically, a central bank should be able to maintain a non-trivial output gap indefinitely.

And while I definitely don’t think Janet Yellen has been trying to prevent an economic boom, I think that’s been the practical effect of her decisions since she took office in early 2014.

This might seem implausible since interest rates have been close to zero ever since 2008. But as Milton Friedman emphasized, low interest rates can be a misleading barometer of whether monetary policy is tight or loose.

It’s useful to go back to earlier in the crisis, when the Fed had cut interest rates to 0 percent and still believed more stimulus was needed. One thing the Fed did was a bond-buying program known as “quantitative easing.” But another thing the Fed did was called “forward guidance.”

Forward guidance meant that the Fed promised to keep interest rates low for a long time — even after the economy started to recover. In 2011, the Fed promised to keep rates low for an “extended period” without specifying how long that period would be. In Septemner 2012, the Fed said that it would maintain low rates “for a considerable time after the economic recovery strengthens.” Then in December, it adopted the “Evans Rule,” which said that interest rates would stay low until the unemployment rate fell below 6.5 percent.

In a narrow sense, the Fed wasn’t “doing anything” when it issued this kind of forward guidance. It was just talking. But economists know that this kind of talk can be powerful. Market actors care about future Fed actions almost as much as they care about current ones. A commitment to maintain low rates in the future means a higher probability that there will be a big and long-lived economic boom, which means that investments made today are more likely to pay off in a few years. So when the Fed commits to easy money in the future, it can stimulate more investment in the present.

Since 2014, the Fed has taken the opposite tack, repeatedly talking about “normalizing” monetary policy — that is, raising interest rates. The Fed has been doing this even though inflation remained well below the Fed’s 2 percent inflation target and GDP growth remained sluggish.

The reason the Fed hasn’t followed through on these threats is that the economy keeps under-performing expectations. An expected June 2015 rate hike was delayed until December after disappointing economic performance in the summer and fall of 2015. The December rate hike happened despite the fact that inflation expectations were falling at the time. That was supposed to be followed by a series of rate hikes in 2016, but at each meeting the Fed has flinched in the face of disappointing economic performance and global economic turmoil.

We can view this policy as the opposite of the stimulative forward guidance the Fed was offering between 2011 and 2013. Back then, the Fed said “don’t worry, we’ll keep rates low even after the economy has recovered. Now, the Fed is saying “watch out! We’re going to hike rates as soon as we’re sure it won’t cause a recession — and maybe sooner.” If promising to keep rates low for an extended period makes monetary policy looser, promising to hike rates ASAP makes it tighter.

And because the Fed’s statements about future policies can effect the economy in the present, promising to raise rates soon can actually cause rates to stay low for longer. The Fed’s signals about impending rate hikes makes markets more pessimistic about the economy’s trajectory. That depresses spending and investment, weakening the economy enough that the Fed is forced to delay its rate increase.

In short, the Fed’s policy over the last couple of years has effectively been to tap on the brakes any time the economy shows signs of producing faster-than-trend growth. And because markets know that’s the Fed’s policy,
they’ve come to expect slow growth, making them less likely to invest in boosting output.

“Full employment” isn’t necessary full employment

OK, so money isn’t as loose as it could be. But the conventional view holds that this doesn’t matter because the unemployment rate is 4.9 percent. That’s very close to the level that economists consider to be “full employment.” With very few idled workers, the argument goes, there’s no room for higher demand to produce higher real output. If the Fed made monetary policy looser, it would just produce more inflation.

But I think this takes too simplistic a view of the concept of full employment. There are a number of ways an economy can be at 4.9 percent unemployment and still be well below its potential output.

One way is known in economics jargon as “scarring.” A bunch of people lost their jobs in 2009. As the recession dragged on, a lot of them couldn’t find work for several years. And once a worker had a multi-year gap in his resume, it became harder and harder to find a job, since employers worried that the worker’s skills were stale or that there was something wrong with the worker that led to the prolonged spell of unemployment. Eventually, many of these workers gave up looking for work altogether. If they were in their 50s or 60s, they may have been forced into a premature retirement. If they were younger, they might have gone on disability, become stay-at-home parents, or moved in with family.

The conventional view treats scarring as an irreversible event: once a worker has left the workforce, he or she’s no longer counted in the unemployment rate and is effectively excluded from the concept of full employment.

But these workers do exist, and they could starting working again with some extra encouragement and training. What they need is a 1990s-style boom, in which employers are so desprate to find workers that they’re willing to hire people they wouldn’t have considered in leaner times. In tight labor markets, employers start asking friends and family if they know of anyone looking for work. They set up training programs to teach skills that are scarce on the ground. And so the labor force can become partially “unscarred,” with thousands of people who had given up on finding work returning to the workforce.

A boom could can also help workers shift into jobs where they’ll be more productive. During a recession or a slow recovery, many workers feel that their job situation is precarious — that if they lose their current job, they’re unlikely to get another one like it. That makes them reluctant to make risky career moves — like switching to a new field, going back to school, or starting a business — that could boost their long-run productivity. As a result, many workers wind up in career ruts, spending years in jobs where they’re performing at well below their level of potential.

In a 1990s-style boom, employers become desperate for workers and workers become confident that they’ll be able to find a decent job if they need one. At the same time, employers become more open to hiring people with unconventional backgrounds, making it easier for people to hop from one industry to another. In short, the labor market becomes more fluid, and this dynamism allows more workers to find jobs where they can maximize their long-term productivity and pay.

A similar point applies to capital investment. Say you’re in charge of a factory and you have a idea for an overhaul that could double output with the same number of workers. However, the refit would be expensive and there’s a risk that the gains won’t pan out.

In a weak recovery, you (or your bosses) might be reluctant to give it a try. If the investment works, you might find the sales force can’t sell all the extra units you’re producing. If the investment doesn’t work, you worry that you (and whoever approved the investment) could lose your jobs. So you might decide that it’s safer to stick with current technology, satisfying small demand increases by hiring more workers and buying more of existing equipment.

In a boom, the calculation looks different. The entire industry is struggling to keep up with soaring demand so there’s little doubt you’ll be able to sell the extra units. You’re not too worried about losing your job because there’s an industry-wide shortage of experienced managers. Indeed, if the project fails but demand is still strong, the CEO might be eager for you to take what you’ve learned and try again.

In short, the fact that the unemployment rate is 4.9 doesn’t prove that the economy is operating at — or even close to — its maximum output. I suspect that if the Fed were to step on the gas, we’d see a sudden surge in labor force participation, investment spending, and total factor productivity. The economy might be at “full employment,” but that doesn’t necessarily mean it’s actually at full employment.

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The Pokémon Go Economy, Explained without a Silly Headline

In a recent Vox post I tried to combine a headline designed to troll my least favorite website — “Pokémon Go is everything that is wrong with late capitalism” — with a serious policy argument. Unfortunately, I think the silly headline overshadowed the content of the article. So let me try to make the point again in a more systematic and (hopefully) clear way.

Suppose you have two regions, Region A and Region B. And suppose that a productivity shock causes output in Region A to grow much faster than output in Region B. Money starts to flow from Region A to Region B much faster than in the opposite direction. Logically speaking, one of five things has to happen:

(1) Workers can move from Region B to Region A.

(2) Companies can move jobs to from Region A to Region B.

(3) A government can tax people in Region A and give the money to people in Region B.

(4) Wages and prices can rise in Region A, causing people in both regions to buy fewer products from Region A and more products from Region B.

(5) Region B can enter into a deflationary spiral — with either falling prices or falling real output.

If Region A is Germany and Region B is Greece, then I’ve just provided a thumbnail explanation of the eurozone crisis. The problem in the Eurozone is that none of these five options is working very well:

(1) Language and cultural barriers make it hard for workers to relocate from Greece to Germany

(2) Language and cultural barriers — and perhaps a lack of relevant skills among Greek workers — make it hard for German companies to move jobs to Greece.

(3) The EU doesn’t have independent taxing authority, and of course the German government doesn’t want to tax Germans and send the money to Greece.

(4) Tight money policies by the European Central Bank have prevented significant price increases in Germany. (The Mercatus Center recently did a great report on this.)

That leaves (5), a deflationary spiral in Greece. Deflationary spirals are painful because because (a) workers really hate taking nominal wage cuts, and (b) Greece has a lot of euro-denominated debt, so falling prices means that Greece’s debt keeps growing as a share of GDP.

This kind of issue, incidentally, is why Milton Friedman warned against the creation of the euro back in 1997. He pointed out that if Greece and Germany have different currencies, then you can make the necessary adjustment by devaluing Greece’s currency — with much less severe consequences than the deflation spiral Greece is suffering today.

OK, so what does all this have to do with Pokemon Go? Well, let’s now change examples and say that Region A is “big American cities” like San Francisco (and their metropolitan areas) and Region B is “real America” — everywhere else. In the last couple of decades, powerful technological and economic forces — of which Pokémon Go is a small but evocative example — have caused productivity in regions like Silicon Valley to skyrocket. The rest of the country has gotten left behind.

The same analysis applies in this case:

(1) Strict regulations have caused severe housing shortages in cities like San Francisco and New York, limiting the number of people who can move there to find work.

(2) Agglomeration effects make it hard to relocate high-skilled, high-paying jobs outside of the biggest cities.

(3) The federal government does tax rich people (who are disproportionately in big cities) and give the money to others (think Social Security, Medicare, food stamps, farm subsidies, etc), but recent economic data suggests that these policies have not been sufficient to prevent the economies of big cities from diverging from the rest of the country.

(4) Thanks to tight-money policies by the Federal Reserve, inflation has been below the Fed’s 2 percent target, leaving little room for inflation in big cities to accomplish the needed economic adjustments.

(5) That leaves sluggish growth in the rest of the US. To be sure, the economies of Cleveland or Memphis aren’t in nearly as bad shape as the economy of Greece. But small cities and rural areas are suffering the worst economic recovery in decades even as big cities are booming.

To solve the problem, policymakers could attack any one of the first four issues: (1) They could deregulate housing. (2) They could invest more in education and infrastructure so more jobs could move to smaller cities (thought his could take decades and may or may not work). (3) They could raise taxes on the rich and make government transfer programs more generous. (4) The Fed could cut interest rates to boost economic growth generally.

Personally, I’m most enthusiastic about options (1) and (4). I’m skeptical that option (2) is going to work, though it’s probably worth trying. And I worry that these options may not be enough, and we may ultimately be forced to adopt some of option (3).

Ultimately the point here isn’t that Pokémon Go is bad. Obviously, consumer surplus is a good thing. The point is that our existing policies and economic institutions aren’t set up to deal with the emerging internet economy, in which a hugely disproportionate share of the wealth is created by a handful of big cities.

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Fred Hirsch’s Social Limits to Growth

After my last post, reader Joe pointed out the parallels to Fred Hirsch’s classic book the Social Limits to Growth. I hadn’t read Hirsch’s book, but the similarity isn’t entirely a coincidence, since my argument relies heavily on the concept of positional goods that Hirsch invented.

I just finished reading the book, and it seems to me that he takes the the same basic idea — some goods have inherently limited supply — and takes things in a needlessly gloomy direction. Americans might have a chicken in every pot and a car in every garage, Hirsch argues, but it’s never going to be possible for everyone to have a vacation home in the Hamptons or send their kids to Harvard. For Hirsch, the growing importance of these kinds of positional goods will mean more frustration and social conflict.

But Hirsch never really makes a convincing case that we should view this as a problem we need to solve rather than just a fact of life that people should learn to live with.

One way I think Hirsch goes astray here is by adopting a definition of positional goods that’s far too broad. One of his key examples of how the struggle for positional goods is making us miserable is the growth in college education. He points out that as college educations have become more common, jobs that once required only a high school diploma now require a college degree. If he’d been writing today he might have pointed out that some jobs that once required a bachelor’s degree now require a master’s degree.

It’s not crazy to believe that the inflation of educational requirements is a problem, but it’s not clear what the positional good in this story is supposed to be. There’s a limited supply of seats at particular schools — like Harvard or Yale — but there’s no necessary limit on the number of college degrees awarded in general. And while having a degree from Harvard gives applicants a leg up in the job market, this effect becomes much weaker once you move a few rungs down the college ranking charts. Is the University of Northern Iowa more or less prestigious than the University of Minnesota — Duluth? Most employers don’t know or care, they just want to know you earned a college degree somewhere.

Hirsch also seems to imply that good jobs are a scarce positional good, and that people have to go to more and more educational effort to secure one of those scarce good jobs. But here again, good jobs are positional only at the very high end of the job market. By definition, there can only be 500 CEOs of Fortune 500 companies, for example. And there are a few professions like medicine where high barriers to entry make the jobs effectively positional.

But this isn’t really true of the economy as a whole. The number of companies isn’t fixed, nor is the number of positions in any given company. In many skilled professions, employers are constantly looking for more skilled practitioners they can hire.

That’s just one example of my broader point, which is that Hirsch sees positional goods everywhere and claims that as we get richer, human lives will become increasingly consumed by our struggle to gain positional goods. But I think that’s unduly pessimistic, because it’s almost always possible to opt out of positional competitions and still live a happy life. If you can’t afford to live in Manhattan, you can live a perfectly fulfilling life in Minneapolis or Omaha. If you can’t afford to send your kid to Harvard, she’ll do just fine at Penn State or the University of Northern Iowa. Nobody’s happiness depends on owning a Rembrandt.

People sometimes make themselves miserable by entering positional competitions they can’t afford to win. But the right lesson to draw here isn’t that positional goods are causing an inevitable social crisis — it’s that people should learn to keep positional goods in perspective. You can live a perfectly happy life without them.

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Some thoughts on the end of economic growth

Here are some thoughts on economic growth that aren’t yet coherent enough to be a Vox article…

1. Technological progress in a particular industry often has diminishing returns, and it’s possible to reach the point where it’s hard to imagine significant further improvements.

2. Clothing is the best example. Americans tend to run out of closet space before we run out of money to buy clothes. The fraction of our household incomes we spend on clothing has been steadily declining, even as we own dozens of outfits each.

3. As the production costs of clothing have continued to fall, a larger and larger fraction of the value people get from the clothing they buy — especially at the high end of the market — reflects social factors rather than economic ones. Someone might pay $40 for a T-shirt that cost $5 to produce because it carries the label of a famous designer.

4. For products like this, there’s little room for technological progress to lower clothing costs further. A 2x improvement in textile manufacturing productivity might reduce the shirt’s $5 manufacturing cost to $2.50. But we shouldn’t expect technological progress to reduce the $35 that goes to the designer and retailer. They’re selling exclusivity as much as they’re selling a piece of clothing.

5. A similar point can be made about food. The average American family has been able to comfortably afford more than enough food for many decades. And the quality and variety of food available to the average American has been steadily improving over time. Supermarkets now offer such a wide variety of high-quality, convenient food that there seems to be little room for further improvement. As with clothing, food prepared at home has become a smaller and smaller fraction of households budgets, even as the quality and variety of the food we consume has improved.

6. As ingredients have gotten cheaper and incomes have risen, we’ve spent less at the grocery store and more at restaurants. As with high-end clothing, most of the value of a restaurant meal comes from factors that can’t easily be improved by technology. Restaurants with human waiters tend to be more prestigious than restaurants that make you order at the counter precisely because people like to have other people serving them. If you figured out a way to serve fancy restaurant food from a vending machine, people would not see that as an improvement.

7. So families have been spending a shrinking share of their incomes on basic necessities like food and clothing. Where has their income gone instead? During the 20th century, there was a steady stream of new inventions — cars, televisions, washing machines, refrigerators, telephones, electric lighting, personal computers, and so forth — that soaked up peoples’ growing disposable income.

8. Over the last 30 years, this process has continued for information technology — we’ve seen the invention and widespread adoption of personal computers, gaming consoles, DVD players, smartphones, and so forth. VR headsets seem to be the next big thing. But outside of the IT sector, significant new inventions have been few and far between. Today’s kitchens have the same suite of labor-saving appliances — a refrigerator, oven, dishwasher, microwave, blender, and so forth — as the kitchens of the 1980s.

9. There has been a big debate about whether there has been a “slowdown in innovation” — with the implication that this represents a flaw in the way our economic system is working. But maybe we’re just running out of big problems that could be solved with technology.

10. One way to see this is to look at how wealthy Americans spend their money. A century ago, rich people could spend their money on a wide variety of technological luxury goods — electric lighting, telephones, automobiles, indoor plumbing — that substantially improved their quality of life. Today, very wealthy people have private jets, but otherwise it’s hard to think of examples of major technologies that are available to them but not to Americans with more modest incomes.

11. Instead, wealthy people spend money on two things that are not really amenable to technological improvement: positional goods (famous paintings, Manhattan real estate, Harvard tuition) and labor-saving services (nannies, housekeepers, chess tutors, art dealers).

12. As we get wealthier, I expect the previous point to describe the budgets of more and more Americans. People in large coastal cities are spending more and more money on housing in desirable locations — a positional good. And as the cost of food, clothing, furniture, and other goods has declined, child care costs have loomed larger and larger as a factor in the budgets of two-income households.

13. Education also fits this pattern. People are spending more and more money to send their children to fancy schools and colleges. And I while some aspects of the educational process can be improved by technology, elite schools mostly have the characteristics of a positional good. You can view a lot of MIT classes online for free, but people still seem to be willing to pay hundreds of thousands of dollars for their kids to be members of MIT’s undergraduate class — because what they’re really buying is access to an exclusive club.

14. I think we’re running out of room for technological improvements in most areas of economic life, with three big exceptions: IT, medicine and transportation. The IT part is obvious — smartphones were just invented recently, and VR seems likely to become a big market in the next few years. Obviously, if someone finds a cure for cancer, heart disease, or AIDS, that would create a tremendous amount of value. It’s also easy to imagine transportation technologies that people would pay a lot of money for: self-driving cars, affordable private airplanes, personal helicopters, supersonic airplane flights, space travel. It’s possible that physics or logistical constraints will prevent these from ever coming to fruition, but we can at least imagine ways these products could get better.

15. Energy is a third area where there seems to be a lot of room for progress — especially in solar panel and battery technology, as well as electric cars. But this is an interesting case because the primary selling point isn’t that they will make our lives qualitatively better so much as that they’ll help prevent a worsening of our collective living standards due to climate change.

16. This isn’t to say that there’s no room for further economic growth. Most American families can comfortably afford food, clothing, and shelter, but we’d all like these things to consume a smaller share of our incomes. More important, there are still some people in the United States and billions of people outside the United States who have yet to achieve the standard of living most of the people reading this post take for granted. It will take several more decades, at least, for the median income in countries likes India and Nigeria to reach American levels.

17. What this does mean, however, is that in the future most growth may be “catch-up growth,” in the sense that the economy will be focused on providing more and more people with the same standard of living that someone in the top income quintile of the United States enjoys today. That’s different from the 20th century, when even wealthy families could look forward to inventions (like air conditioning, televisions, and the internet) that would provide dramatic improvements in their standard of living.

18. This also means that we should expect a gradual slowdown in productivity growth rates. As people get wealthier, a smaller and smaller share of their household income will be devoted to goods and services that are amenable to technological improvement.

19. This could be seen as a pessimistic take, but the optimistic way to think about it is that Americans in the top half of the income distribution have arrived: we’re getting pretty close to the highest level of material comfort and security that it’s possible for a human civilization to have. Our children and grandchildren probably won’t enjoy a much higher standard of living than we do, but that’s mostly because it’s hard to imagine what a much higher standard of living would look like.

Update: I tweaked the example in point 3 after Saku Panditharatne convinced me that the original version was overstating my case.

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How to be better at PR

Most of my experience with PR people involves them cluttering my inbox with unwanted pitches. But yesterday I had a PR experience that was so positive that I thought it was worth sharing. In an ideal world, this is how most PR professionals would do their job.

I was working on a story about mattress shopping, so I sent out a tweet:

I was mostly hoping that a former mattress salesman would see it and give me an inside perspective on the negotiation process. But I was also interested in hearing from others with experience in the industry.

Just 90 minutes later, I got an email from Phil Krim, CEO of the mattress startup Casper:

Hi Tim-

How are you? Lindsay, our VP of Communications, sent me your tweet about
looking for mattress industry experts. I have had a great deal of
experience in the space. Anything I can do to help you?

Thank you.


I don’t know Lindsay Kaplan, Casper’s VP of communications, but she did two things that are rare in the PR world.

First, she paid attention to what I was doing and figured out a way to help me out. I was looking for information about the mattress business. Casper is in the mattress business. So talking to Casper’s CEO was actually useful to me.

It’s astonishing how rare this is. There are dozens of companies in the mattress business. Presumably all of them would like favorable press coverage. Yet Casper was the only company that noticed my tweet and got in touch with me.

And the email was written in a way that made my job easier. Krim didn’t send me a wall of text explaining how great Casper mattresses were. He just let me know that he was available to talk.

Second, Kaplan stayed out of the way. Instead of sending me an email offering to put me in touch with Krim, she had Krim email me directly. That signalled that Krim was actually interested in talking to me and actually available to talk. And he was — when I responded with my phone number, he called me in a few minutes.

I’m way more likely to respond to a personal email from a potential interview subject than I am to a PR person trying to arrange an interview for someone else. Long experience has taught me that these third-party pitches are usually a hassle to deal with. The subject might not actually be that interested in talking to me, or it might take several hours to find space on his calendar.

Kaplan’s work got results. If Krim hadn’t contacted me, I wouldn’t have written about Caplan or its “bed in a box” competitors, because I simply didn’t know they existed. Krim’s email (and subsequent phone interview) convinced me to learn more. And my independent research found that these companies had a lot of satisfied customers. So I wound up adding a whole section discussing this product category.

If you’re a PR person, you should be doing your job more like Lindsay Kaplan. Instead of sending out press releases indiscriminately, learn about the specific reporters who cover the topics you’re working on and look for opportunities to help them out. And don’t get in the way. Whenever possible, pitches should come directly from the would-be interview subject.

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Dorian Nakamoto: “I did not create, invent or otherwise work on Bitcoin”

Last month, an engineer named Dorian Nakamoto was identified by Newsweek as Satoshi Nakamoto, the creator of Bitcoin. Early Monday morning, Dorian issued his strongest statement yet denying the report. Here is his full statement:

My name is Dorian Satoshi Nakamoto. I am the subject of the Newsweek story on Bitcoin. I am writing this statement to clear my name.

I did not create, invent or otherwise work on Bitcoin. I unconditionally deny the Newsweek report.

The first time I heard the term “bitcoin” was from my son in mid-February 2014. After being contacted by a reporter, my son called me and used the word, which I had never before heard. Shortly thereafter, the reporter confronted me at my home. I called the police. I never consented to speak with the reporter. In an ensuing discussion with a reporter from the Associated Press, I called the technology “bitcom.” I was still unfamiliar with the term.

My background is in engineering. I also have the ability to program. My most recent job was as an electrical engineer troubleshooting air traffic control equipment for the FAA. I have no knowledge of nor have I ever worked on cryptography, peer to peer systems, or alternative currencies.

I have not been able to find steady work as an engineer or programmer for ten years. I have worked as a laborer, polltaker, and substitute teacher. I discontinued my internet service in 2013 due to severe financial distress. I am trying to recover from prostate surgery in October 2012 and a stroke I suffered in October of 2013. My prospects for gainful employment has been harmed because of Newsweek’s article.

Newsweek’s false report has been the source of a great deal of confusion and stress for myself, my 93-year old mother, my siblings, and their families. I offer my sincerest thanks to those people in the United States and around the world who have offered me their support. I have retained legal counsel. This will be our last public statement on this matter. I ask that you now respect our privacy.

Dorian Satoshi Nakamoto
Temple City, California
March 17, 2014

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Why Satoshi Nakamoto worked so hard to hide his identity

We may now know who Satoshi Nakamoto, the creator of Bitcoin, is. According to Newsweek, he’s a reclusive 64-year old Japanese man who lives in Temple City, California. And Satoshi Nakamoto is his real name. (He has reportedly denied being involved with Bitcoin.)

Newsweek portrays Nakamoto as secretive, reclusive and a little paranoid. And certainly the awkward scene when Leah McGrath Goodman confronted Nakamoto in his driveway suggests that the man is genuinely uninterested in seeking the spotlight.

But Nakamoto’s decision to disappear from public view just as Bitcoin was taking off wasn’t just a reflection of his eccentric personality. It was essential to getting the currency to take off.

Fiat curencies like Bitcoin are fundamentally built on faith. People treat a currency as valuable because they expect others to consider it valuable. And for a decentralized currency like Bitcoin, that faith depends on a belief that the rules of the currency will be stable over time.

For example, it’s generally reported as a fact that there will never be more than 21 million bitcoins. But that “fact” is just a social convention. There will never be more than 21 million Bitcoins because the Bitcoin community has agreed to a set of rules that doesn’t allow more than 21 million Bitcoins to be created. In principle, those rules could be changed. Bitcoin’s success depends on people having confidence that the rules won’t be changed in a way that will destroy the value of their holdings.

This means that a strong leader would have been a liability in Bitcoin’s early years. As Bitcoin’s creator, Satoshi Nakamoto would have had a unique ability to change the rules of the game and get the Bitcoin community to accept the changes—Nakamoto’s version of the Bitcoin software was Bitcoin by definition. As long as he was around, people would worry that he could make future changes that would destroy the value of their investments.

Disappearing in early 2011 helped to remove that potential impediment to Bitcoin’s growth. Gavin Andresen, Nakamoto’s successor as the leader of the Bitcoin project, is a smart and capable programmer. But he’ll never have the stature within the Bitcoin community that Nakamoto did. If Andressen tried to make dramatic, potentially harmful changes to Bitcoin, he’d face a lot of resistance from the rest of the Bitcoin community.

The lack of an official Bitcoin leader has also been an asset in the regulatory arena. A key argument for Bitcoin is that no one owns the Bitcoin network, which means there’s no way to regulate it. Had Nakamoto’s identity been known a year ago, he might have been dragged before Congress to testify at last fall’s hearings on the future of Bitcoin. Nakamoto might have faced pressure from regulators to change Bitcoin to make it easier to regulate. But with Nakamoto out of the picture, the leaders of the Bitcoin community could truthfully say that no one had the authority to change Bitcoin’s rules. That forced policymakers to accept the system the way it was and develop policies to accommodate it.

If the man Newsweek identified today proves to be the real Satoshi Nakamoto, the question is whether he’s been away from the project long enough that Bitcoin will continue to be seen as truly outside anyone’s control. I think the answer is probably yes. There’s now a significant community of Bitcoin developers who have grown used to managing the currency without Nakamoto’s input. They probably wouldn’t defer to him the way they would have in 2011. But just to be on the safe side, it would be smart for Nakamoto not to rejoin the Bitcoin development community any time soon.

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The case against land value taxes

Alice and Bob were both born in 1957, and became friends after they both settled in Washington, DC. In 1986, Alice bought a 2-bedroom home in the up-and-coming Dupont Circle neighborhood. Bob thought owning a home sounded like a lot of work, so he rented a similarly-sized apartment instead. His rent was cheaper than what Alice paid for her mortgage and local property taxes, and each month he put the difference into a 401(k).

Fast forward to 2016. Alice and Bob are 59 years old. Alice’s house is now worth $750,000. She’s paid off her mortgage but doesn’t have any other savings. Bob is still a renter, but over the years the value of his 401(k) has risen to $750,000.

Neither of them is wealthy, but each figures they’ll be in pretty good shape when they retire. Since Alice owns her home outright, she won’t have to devote any of her Social Security check to paying the rent. Bob expects his $750,000 nest egg to generate an income of around $2500 per month, which will just cover his rent payment.

In November, Joe Biden is elected president. The overwhelming success of Obamacare has given the Democrats large majorities in both houses of Congress. And at the top of Biden’s agenda is a cause that’s been championed by prominent bloggers like Matthew Yglesias.

A few years earlier, Yglesias had calculated that the value of all land in the United States was worth $14.5 trillion. Four years later, the figure was $17 trillion. The income tax is projected to generate taxes of $1.7 trillion in fiscal year 2018, so Biden’s advisors propose that the income tax be cut in half, with the lost $850 billion in revenue being made up with a 5 percent land value tax.

Bob likes this idea. He makes $100,000 per year and pays about $1500 per month in federal income taxes. With taxes cut in half, he’ll be able to squirrel away an extra $750 per month, increasing his retirement savings by $50,000 by the time he turns 65.

But Alice isn’t so enthusiastic. She makes the same salary as Bob and will get the same $750-per-month tax cut. But because she’s a homeowner, she’s going to owe additional taxes. The Internal Revenue Service has determined that $600,000 of her home’s $750,000 value is attributable to the value of the land underneath the home. So her land value tax bill is $2500 per month. The net change to her tax bill is $1750 per month.

Alice doesn’t have an extra $1750 lying around each month to spend on land value taxes. She can scrape together an extra $750 per month, but beyond that she realizes she’s going to have to tap her home equity to help pay the higher taxes.

But then she encounters a big problem: the value of her home has plummeted. Before the land value tax, people would have paid her $750,000 for her home, which would have meant a mortgage payment of around $3000 per month. But now owning her home means a liability of $2500 in land value taxes alone. Potential buyers take this extra cost into account, and it reduces the amount they are willing to pay for the house from $750,000 to $150,000.

Each year, Alice takes out a home equity loan of $12,000 to help her cover the added cost of the land value tax. But by her 70th Birthday, her home equity has dwindled to the point where the bank won’t lend her any more money. She’s forced to sell, with the sale netting her $30,000.

Alice is justifiably angry about the land value tax. Over the course of their careers, Alice and Bob both worked hard and saved significant sums. While they chose to invest in different assets, their investments had similar value in 2016. It’s not fair that a decade later Alice’s choice to invest in real estate would leave her penniless while Bob’s choice to invest in stocks and bonds would give him a windfall.

Advocates of a land value tax emphasize its efficiency, but efficiency isn’t the only thing that matters for tax policy. Fairness is also important. Similarly-situated individuals should pay similar taxes. A high land value tax fails this test, imposing potentially ruinous taxes on those who have chosen to invest their savings in real estate for the benefit of those who have invested in stocks or bonds.

This story illustrates another important point too: while the land value tax is paid over time, the burden of the tax (its incidence, in economics jargon) falls entirely on the person who owned property at the time the tax was instituted. The value of future taxes gets immediately priced into the value of real estate. For those who buy property after the tax is instituted, the higher property taxes are offset by lower mortgage payments.

In other words, the economic efficiency of the land value tax comes from the fact that it operates by confiscating wealth accumulated in the past rather than taxing the accumulation of new wealth. This, too, is unfair. Society benefits when people defer gratification and save for the future. People justifiably expect that if they save today, they’ll enjoy the benefits of that accumulated savings in the future. Of course, people who generate income from their accumulated wealth should pay their fair share of taxes. But a land value tax goes way beyond that point, depriving owners of one particular asset class of the benefits of decades of thrift.

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Here’s why Bitcoin-the-network needs Bitcoin-the-currency

This week I was making the argument on Twitter that it’s more helpful to think about Bitcoin as a new kind of payment network than a new kind of currency. Multiple people asked variants of the same question: if the goal is to create a new kind of financial network, why base it on an alternative currency? Why not just create a new payment network based on a conventional, stable currency like the dollar?

It’s a good question, and I think the answer comes in three parts:

1. Bitcoin’s potential for innovation comes from its openness. Anyone is free to create Bitcoin-based software or services. That will allow more experimentation and faster innovation than with conventional payment networks like Paypal or Mastercard.

2. That openness comes from the fact that no one owns or controls the Bitcoin network. If there were a “Bitcoin Inc.” with authority to oversee the Bitcoin network, that company would come under immense pressure to comply with a variety of legal obligations, for example policing the network for fraudulent transactions. To deal with those obligations, the company would be forced to become increasingly picky about who was allowed to participate in the network and what they’re allowed to do.

3. If there’s no company controlling a financial network, then there’s no way to guarantee that the unit of account inside the network is pegged to some stable unit of value outside of it. Dollars in Paypal are worth a dollar because the Paypal company has promised to pay a dollar to anyone who wants to withdraw their funds. But in a peer-to-peer network, there’s no one to perform this function. So a fully decentralized financial network necessarily needs to use its own unit of account that floats against conventional currencies.

Paul Haahr had an interesting response to this line of argument: for Bitcoin to be useful, doesn’t it need to integrate with the conventional financial system? And won’t those points of integration make the consumer-facing parts of the network just as bureaucratic as a conventional payment network?

I think the answer to the first question is clearly “yes.” Answering the second question is complicated.

Every consumer-friendly financial network needs to have some kind of strategy for combatting fraud. Ordinarily, this takes the form of the network operator accepting liability for unauthorized transactions and then establishing rules that minimize the amount of fraud that occurs. But there are many possible strategies for detecting and combatting fraud.

In a centralized network, the whole network has to adopt a single unified strategy for fraud prevention. Because the network operator is on the hook for any losses, those rules tend to be pretty conservative. To become a Visa or Mastercard merchant, for example, you have to participate in a lengthy approval process and comply with a variety of complex requirements. This is not very conducive to innovation.

In contrast, an open financial network allows different payment processors to adopt different strategies for combatting fraud. Some might require consumers to adopt sophisticated techniques like two-factor authentication before they can spend Bitcoins. Others might set fairly low limits on how much consumers can spend in a day.

Some might only allow payments to merchants that agree to refund payments that later prove to be fraudulent. Others might use sophisticated machine learning algorithms to try to guess which transactions are likely to be fraudulent. Still others might cater to large organizations who already have elaborate systems for controlling payments. And of course, payment processors could use these techniques in any combination.

It’s true that in the long run, many of these consumer-facing payment processors will be forced to take the same kinds of elaborate precautions that conventional networks like MasterCard and Paypal do. But the barrier to entry is much lower for a Bitcoin-based payment processor. Thanks to the standardized Bitcoin protocol, a new Bitcoin payment processor can immediately send payments to everyone else on the Bitcoin network. So there can be a constant stream of new companies bringing new ideas—and a fresh willingness to ignore the rules while pioneering new approaches—to the network. In contrast, a company like Paypal has to build its network from scratch, a much more daunting proposition.

There’s an obvious parallel to the Internet here. Large Internet companies such as Google and Yahoo are required to comply with laws around the world regulating libel, indecency, copyright infringement, the sale of Nazi memorabilia, and so forth. Yet the Internet’s decentralized architecture makes it a much more hospitable place for freedom of speech than it would be if there were a single Internet, Inc. that could be held legally responsible for everything that appears on the Internet. If major Internet intermediaries were held liable for website content, there’d be an elaborate rulebook every website operator had to comply with before he was allowed to start a website. In that environment, services like YouTube or Facebook would have never gotten started.

So that’s why Bitcoin-the-network needs Bitcoin-the-currency. Innovation requires openness. Openness required decentralization. And decentralization is only possible on a network with its own unit of account.

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