CEO pay

Toward an economics of social norms

pnrj critique of neoclassical economics, heuristics and biases , , , , , , , , , , , , , , , , , , ,

Sep 17, JDN 2457649

It is typical in economics to assume that prices are set by perfect competition in markets with perfect information. This is obviously ridiculous, so many economists do go further and start looking into possible distortions of the market, such as externalities and monopolies. But almost always the assumption is still that human beings are neoclassical rational agents, what I call “infinite identical psychopaths”, selfish profit-maximizers with endless intelligence and zero empathy.

What happens when we recognize that human beings are not like this, but in fact are empathetic, social creatures, who care about one another and work toward the interests of (what they perceive to be) their tribe? How are prices really set? What actually decides what is made and sold? What does economics become once you understand sociology? (The good news is that experiments are now being done to find out.)

Presumably some degree of market competition is involved, and no small amount of externalities and monopolies. But one of the very strongest forces involved in setting prices in the real world is almost completely ignored, and that is social norms.

Social norms are tremendously powerful. They will drive us to bear torture, fight and die on battlefields, even detonate ourselves as suicide bombs. When we talk about “religion” or “ideology” motivating people to do things, really what we are talking about is social norms. While some weaker norms can be overridden, no amount of economic incentive can ever override a social norm at its full power. Moreover, most of our behavior in daily life is driven by social norms: How to dress, what to eat, where to live. Even the fundamental structure of our lives is written by social norms: Go to school, get a job, get married, raise a family.

Even academic economists, who imagine themselves one part purveyor of ultimate wisdom and one part perfectly rational agent, are clearly strongly driven by social norms—what problems are “interesting”, which researchers are “renowned”, what approaches are “sensible”, what statistical methods are “appropriate”. If economists were perfectly rational, dynamic stochastic general equilibrium models would be in the dustbin of history (because, like string theory, they have yet to lead to a single useful empirical prediction), research journals would not be filled with endless streams of irrelevant but impressive equations (I recently read one that basically spent half a page of calculus re-deriving the concept of GDP—and computer-generated gibberish has been published, because its math looked so impressive), and instead of frequentist p-values (and often misinterpreted at that), all the statistics would be written in the form of Bayesian logodds.

Indeed, in light of all this, I often like to say that to a first approximation, all human behavior is social norms.

How does this affect buying and selling? Well, first of all, there are some things we refuse to buy and sell, or at least that most of us refuse to buy and sell, and who use social pressure, public humilitation, or even the force of law to prevent. You’re not supposed to sell children. You’re not supposed to sell your vote. You’re not even supposed to sell sexual favors (though every society has always had a large segment of people who do, and more recently people are becoming more open to the idea of at least decriminalizing it). If we were neoclassical rational agents, we would have no such qualms; if we want something and someone is willing to sell it to us, we’ll buy it. But as actual human beings with emotions and social norms, we recognize that there is something fundamentally different about selling your vote as opposed to selling a shirt or a television. It’s not always immediately obvious where to draw the line, which is why sex work can be such a complicated issue (You can’t get paid to have sex… unless someone is filming it?). Different societies may do it differently: Part of the challenge of fighting corruption in Third World countries is that much of what we call corruption—and which actually is harmful to long-run economic development—isn’t perceived as “corruption” by the people involved in it, just as social custom (“Of course I’d hire my cousin! What kind of cousin would I be if I didn’t?”). Yet despite all that, almost everyone agrees that there is a line to be drawn. So there are whole markets that theoretically could exist, but don’t, or only exist as tiny black markets most people never participate in, because we consider selling those things morally wrong. Recently a whole subfield of cognitive economics has emerged studying these repugnant markets.

Even if a transaction is not considered so repugnant as to be unacceptable, there are also other classes of goods that are in some sense unsavory; something you really shouldn’t buy, but you’re not a monster for doing so. These are often called sin goods, and they have always included drugs, alcohol, and gambling—and I do mean always, as every human civilization has had these things—they include prostitution where it is legal, and as social norms change they are now beginning to include oil and coal as well (which can only be good for the future of Earth’s climate). Sin goods are systematically more expensive than they should be for their marginal cost, because most people are unwilling to participate in selling them. As a result, the financial returns for producing sin goods are systematically higher. Actually, this could partially explain why Wall Street banks are so profitable; when the banking system is corrupt as it is—and you’re not imagining that; laundering money for terrorists—then banking becomes a sin good, and good people don’t want to participate in it. Or perhaps the effect runs the other way around: Banking has been viewed as sinful for centuries (in Medieval times, usury was punished much the same way as witchcraft), and as a result only the sort of person who doesn’t care about social and moral norms becomes a banker—and so the banking system becomes horrifically corrupt. Is this a reason for good people to force ourselves to become bankers? Or is there another way—perhaps credit unions?

There are other ways that social norms drive prices as well. We have a concept ofa “fair wage”, which is quite distinct from the economic concept of a “market-clearing wage”. When people ask whether someone’s wage is fair, they don’t look at supply and demand and try to determine whether there are too many or too few people offering that service. They ask themselves what the labor is worth—what value has it added—and how hard that person has worked to do it—what cost it bore. Now, these aren’t totally unrelated to supply and demand (people are less likely to supply harder work, people are more likely to demand higher value), so it’s conceivable that these heuristics could lead us to more or less achieve the market-clearing wage most of the time. But there are also some systematic distortions to consider.

Perhaps the most important way fairness matters in economics is necessities: Basic requirements for human life such as food, housing, and medicine. The structure of our society also makes transportation, education, and Internet access increasingly necessary for basic functioning. From the perspective of an economist, it is a bit paradoxical how angry people get when the price of something important (such as healthcare) is increased: If it’s extremely valuable, shouldn’t you be willing to pay more? Why does it bother you less when something like a Lamborghini or a Rolex rises in price, something that almost certainly wasn’t even worth its previous price? You’re going to buy the necessities anyway, right? Well, as far as most economists are concerned, that’s all that matters—what gets bought and sold. But of course as a human being I do understand why people get angry about these things, and it is because they have to buy them anyway. When someone like Martin Shkreli raises the prices on basic goods, we feel exploited. There’s even a way to make this economically formal: When demand is highly inelastic, we are rightly very sensitive to the possibility of a monopoly, because monopolies under inelastic demand can extract huge profits and cause similarly huge amounts of damage to the welfare of their customers. That isn’t quite how most people would put it, but I think that has something to do with the ultimate reason we evolved that heuristic: It’s dangerous to let someone else control your basic necessities, because that gives them enormous power to exploit you. If they control things that aren’t as important to you, that doesn’t matter so much, because you can always do without if you must. So a norm that keeps businesses from overcharging on necessities is very important—and probably not as strong anymore as it should be.

Another very important way that fairness and markets can be misaligned is talent: What if something is just easier for one person than another? If you achieve the same goal with half the work, should you be rewarded more for being more efficient, or less because you bore less cost? Neoclassical economics doesn’t concern itself with such questions, asking only if supply and demand reached equilibrium. But we as human beings do care about such things; we want to know what wage a person deserves, not just what wage they would receive in a competitive market.

Could we be wrong to do that? Might it be better if we just let the market do its work? In some cases I think that may actually be true. Part of why CEO pay is rising so fast despite being uncorrelated with corporate profitability or even negatively correlated is that CEOs have convinced us (or convinced their boards of directors) that this is fair, that they deserve more stock options. They even convince them that their pay is based on performance, by using highly distorted measures of performance. If boards thought more like economic rational agents, when a CEO asked for more pay they’d ask: “What other company gave you a higher offer?” and if the CEO didn’t have an answer, they’d laugh and refuse the raise. Because in purely economic terms, that is all a salary does: it keeps you from quitting to work somewhere else. The competitive mechanism of the market is supposed to then ensure that your wage aligns with your marginal cost and marginal productivity purely due to that.

On the other hand, there are many groups of people who simply aren’t doing very well in the market: Women, racial minorities, people with disabilities. There are a lot of reasons for this, some of which might go away if markets were made more competitive—the classic argument that competitive markets reward companies that don’t discriminate—but many clearly wouldn’t. Indeed, that argument was never as strong as it at first appears; in a society where social norms are strongly in favor of bigotry, it can be completely economically rational to participate in bigotry to avoid being penalized. When Chick-Fil-A was revealed to have donated to anti-LGBT political groups, many people tried to boycott—but their sales actually increased from the publicity. Honestly it’s a bit baffling that they promised not to donate to such causes anymore; it was apparently a profitable business decision to be revealed as supporters of bigotry. And even when discrimination does hurt economic performance, companies are run by human beings, and they are still quite capable of discriminating regardless. Indeed, the best evidence we have that discrimination is inefficient comes from… businesses that persist in discriminating despite the fact that it is inefficient.

But okay, suppose we actually did manage to make everyone compensated according to their marginal productivity. (Or rather, what Rawls derided: “From each according to his marginal productivity, to each according to his threat advantage.”) The market would then clear and be highly efficient. Would that actually be a good thing? I’m not so sure.

A lot of people are highly unproductive through no fault of their own—particularly children and people with disabilities. Much of this is not discrimination; it’s just that they aren’t as good at providing services. Should we simply leave them to fend for themselves? Then there’s the key point about what marginal means in this case—it means “given what everyone else is doing”. But that means that you can be made obsolete by someone else’s actions, and in this era of rapid technological advancement, jobs become obsolete faster than ever. Unlike a lot of people, I recognize that it makes no sense to keep people working at jobs that can be automated—the machines are better. But still, what do we do with the people whose jobs have been eliminated? Do we treat them as worthless? When automated buses become affordable—and they will; I give it 20 years—do we throw the human bus drivers under them?

One way out is of course a basic income: Let the market wage be what it will, and then use the basic income to provide for what human beings deserve irrespective of their market productivity. I definitely support a basic income, of course, and this does solve the most serious problems like children and quadriplegics starving in the streets.

But as I read more of the arguments by people who favor a job guarantee instead of a basic income, I begin to understand better why they are uncomfortable with the idea: It doesn’t seem fair. A basic income breaks once and for all the link between “a fair day’s work” and “a fair day’s wage”. It runs counter to this very deep-seated intuition most people have that money is what you earn—and thereby deserve—by working, and only by working. That is an extremely powerful social norm, and breaking it will be very difficult; so it’s worth asking: Should we even try to break it? Is there a way to achieve a system where markets are both efficient and fair?

I’m honestly not sure; but I do know that we could make substantial progress from where we currently stand. Most billionaire wealth is pure rent in the economic sense: It’s received by corruption and market distortion, not by efficient market competition. Most poverty is due to failures of institutions, not lack of productivity of workers. As George Monblot famously wrote, “If wealth was the inevitable result of hard work and enterprise, every woman in Africa would be a millionaire.” Most of the income disparity between White men and others is due to discrimination, not actual skill—and what skill differences there are are largely the result of differences in education and upbringing anyway. So if we do in fact correct these huge inefficiencies, we will also be moving toward fairness at the same time. But still that nagging thought remains: When all that is done, will there come a day where we must decide whether we would rather have an efficient economy or a just society? And if it does, will we decide the right way?

Why is there a “corporate ladder”?

pnrj cognitive science, critique of neoclassical economics , , , , , , , , , , , , , , , , , , ,

JDN 2457482

We take this concept for granted; there are “entry-level” jobs, and then you can get “promoted”, until perhaps you’re lucky enough or talented enough to rise to the “top”. Jobs that are “higher” on this “ladder” pay better, offer superior benefits, and also typically involve more pleasant work environments and more autonomy, though they also typically require greater skill and more responsibility.

But I contend that an alien lifeform encountering our planet for the first time, even one that somehow knew all about neoclassical economic theory (admittedly weird, but bear with me here), would be quite baffled by this arrangement.

The classic “rags to riches” story always involves starting work in some menial job like working in the mailroom, from which you then more or less magically rise to the position of CEO. (The intermediate steps are rarely told in the story, probably because they undermine the narrative; successful entrepreneurs usually make their first successful business using funds from their wealthy relatives, and if you haven’t got any wealthy relatives, that’s just too bad for you.)

Even despite its dubious accuracy, the story is bizarre in another way: There’s no reason to think that being really good at working in the mail room has anything at all to do with being good at managing a successful business. They’re totally orthogonal skills. They may even be contrary in personality terms; the kind of person who makes a good entrepreneur is innovative, decisive, and independent—and those are exactly the kind of personality traits that will make you miserable in a menial job where you’re constantly following orders.

Yet in almost every profession, we have this process where you must first “earn” your way to “higher” positions by doing menial and at best tangentially-related tasks.

This even happens in science, where we ought to know better! There’s really no reason to think that being good at taking multiple-choice tests strongly predicts your ability to do scientific research, nor that being good at grading multiple-choice tests does either; and yet to become a scientific researcher you must pass a great many multiple-choice tests (at bare minimum the SAT and GRE), and probably as a grad student you’ll end up grading some as well.

This process is frankly bizarre; worldwide, we are probably leaving tens of trillions of dollars of productivity on the table by instituting these arbitrary selection barriers that have nothing to do with actual skills. Simply optimizing our process of CEO selection alone would probably add a trillion dollars to US GDP.

If neoclassical economics were right, we should assign jobs solely based on marginal productivity; there should be some sort of assessment of your ability at each task you might perform, and whichever you’re best at (in the sense of comparative advantage) is what you end up doing, because that’s what you’ll be paid the most to do. Actually for this to really work the selection process would have to be extremely cheap, extremely reliable, and extremely fast, lest the friction of the selection system itself introduce enormous inefficiencies. (The fact that this never even seems to work even in SF stories with superintelligent sorting AIs, let alone in real life, is just so much the worse for neoclassical economics. The last book I read in which it actually seemed to work was Harry Potter and the Sorceror’s Stone—so it was literally just magic.)

The hope seems to be that competition will somehow iron out this problem, but in order for that to work, we must all be competing on a level playing field, and furthermore the mode of competition must accurately assess our real ability. The reason Olympic sports do a pretty good job of selecting the best athletes in the world is that they obey these criteria; the reason corporations do a terrible job of selecting the best CEOs is that they do not.

I’m quite certain I could do better than the former CEO of the late Lehman Brothers (and, to be fair, there are others who could do better still than I), but I’ll likely never get the chance to own a major financial firm—and I’m a lot closer than most people. I get to tick most of the boxes you need to be in that kind of position: White, male, American, mostly able-bodied, intelligent, hard-working, with a graduate degree in economics. Alas, I was only born in the top 10% of the US income distribution, not the top 1% or 0.01%, so my odds are considerably reduced. (That and I’m pretty sure that working for a company as evil as the late Lehman Brothers would destroy my soul.) Somewhere in Sudan there is a little girl who would be the best CEO of an investment bank the world has ever seen, but she is dying of malaria. Somewhere in India there is a little boy who would have been a greater physicist than Einstein, but no one ever taught him to read.

Competition may help reduce the inefficiency of this hierarchical arrangement—but it cannot explain why we use a hierarchy in the first place. Some people may be especially good at leadership and coordination; but in an efficient system they wouldn’t be seen as “above” other people, but as useful coordinators and advisors that people consult to ensure they are allocating tasks efficiently. You wouldn’t do things because “your boss told you to”, but because those things were the most efficient use of your time, given what everyone else in the group was doing. You’d consult your coordinator often, and usually take their advice; but you wouldn’t see them as orders you were required to follow.

Moreover, coordinators would probably not be paid much better than those they coordinate; what they were paid would depend on how much the success of the tasks depends upon efficient coordination, as well as how skilled other people are at coordination. It’s true that if having you there really does make a company with $1 billion in revenue 1% more efficient, that is in fact worth $10 million; but that isn’t how we set the pay of managers. It’s simply obvious to most people that managers should be paid more than their subordinates—that with a “promotion” comes more leadership and more pay. You’re “moving up the corporate ladder” Your pay reflects your higher status, not your marginal productivity.

This is not an optimal economic system by any means. And yet it seems perfectly natural to us to do this, and most people have trouble thinking any other way—which gives us a hint of where it’s probably coming from.

Perfectly natural. That is, instinctual. That is, evolutionary.

I believe that the corporate ladder, like most forms of hierarchy that humans use, is actually a recapitulation of our primate instincts to form a mating hierarchy with an alpha male.

First of all, the person in charge is indeed almost always male—over 90% of all high-level business executives are men. This is clearly discrimination, because women executives are paid less and yet show higher competence. Rare, underpaid, and highly competent is exactly the pattern we would expect in the presence of discrimination. If it were instead a lack of innate ability, we would expect that women executives would be much less competent on average, though they would still be rare and paid less. If there were no discrimination and no difference in ability, we would see equal pay, equal competence, and equal prevalence (this happens almost nowhere—the closest I think we get is in undergraduate admissions). Executives are also usually tall, healthy, and middle-aged—just like alpha males among chimpanzees and gorillas. (You can make excuses for why: Height is correlated with IQ, health makes you more productive, middle age is when you’re old enough to have experience but young enough to have vigor and stamina—but the fact remains, you’re matching the gorillas.)

Second, many otherwise-baffling economic decisions make sense in light of this hypothesis.

When a large company is floundering, why do we cut 20,000 laborers instead of simply reducing the CEO’s stock option package by half to save the same amount of money? Think back to the alpha male: Would he give himself less in a time of scarcity? Of course not. Nor would he remove his immediate subordinates, unless they had done something to offend him. If resources are scarce, the “obvious” answer is to take them from those at the bottom of the hierarchy—resource conservation is always accomplished at the expense of the lowest-status individuals.

Why are the very same poor people who would most stand to gain from redistribution of wealth often those who are most fiercely opposed to it? Because, deep down, they just instinctually “know” that alpha males are supposed to get the bananas, and if they are of low status it is their deserved lot in life. That is how people who depend on TANF and Medicaid to survive can nonetheless vote for Donald Trump. (As for how they can convince themselves that they “don’t get anything from the government”, that I’m not sure. “Keep your government hands off my Medicare!”)

Why is power an aphrodisiac, as well as for many an apparent excuse for bad behavior? I’ll let Cameron Anderson (a psychologist at UC Berkeley) give you the answer: “powerful people act with great daring and sometimes behave rather like gorillas”. With higher status comes a surge in testosterone (makes sense if you’re going to have more mates, and maybe even if you’re commanding an army—but running an investment bank?), which is directly linked to dominance behavior.

These attitudes may well have been adaptive for surviving in the African savannah 2 million years ago. In a world red in tooth and claw, having the biggest, strongest male be in charge of the tribe might have been the most efficient means of ensuring the success of the tribe—or rather I should say, the genes of the tribe, since the only reason we have a tribal instinct is that tribal instinct genes were highly successful at propagating themselves.

I’m actually sort of agnostic on the question of whether our evolutionary heuristics were optimal for ancient survival, or simply the best our brains could manage; but one thing is certain: They are not optimal today. The uninhibited dominance behavior associated with high status may work well enough for a tribal chieftain, but it could be literally apocalyptic when exhibited by the head of state of a nuclear superpower. Allocation of resources by status hierarchy may be fine for hunter-gatherers, but it is disastrously inefficient in an information technology economy.

From now on, whenever you hear “corporate ladder” and similar turns of phrase, I want you to substitute “primate status hierarchy”. You’ll quickly see how well it fits; and hopefully once enough people realize this, together we can all find a way to change to a better system.

Free trade is not the problem. Billionaires are the problem.

pnrj development economics, ethics, inequality, public policy , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457468

One thing that really stuck out to me about the analysis of the outcome of the Michigan primary elections was that people kept talking about trade; when Bernie Sanders, a center-left social democrat, and Donald Trump, a far-right populist nationalist (and maybe even crypto-fascist) are the winners, something strange is at work. The one common element that the two victors seemed to have was their opposition to free trade agreements. And while people give many reasons to support Trump, many quite baffling, his staunch protectionism is one of the stronger voices. While Sanders is not as staunchly protectionist, he definitely has opposed many free-trade agreements.

Most of the American middle class feels as though they are running in place, working as hard as they can to stay where they are and never moving forward. The income statistics back them up on this; as you can see in this graph from FRED, real median household income in the US is actually lower than it was a decade ago; it never really did recover from the Second Depression:

US_median_household_income

As I talk to people about why they think this is, one of the biggest reasons they always give is some variant of “We keep sending our jobs to China.” There is this deep-seated intuition most Americans seem to have that the degradation of the middle class is the result of trade globalization. Bernie Sanders speaks about ending this by changes in tax policy and stronger labor regulations (which actually makes some sense); Donald Trump speaks of ending this by keeping out all those dirty foreigners (which appeals to the worst in us); but ultimately, they both are working from the narrative that free trade is the problem.

But free trade is not the problem. Like almost all economists, I support free trade. Free trade agreements might be part of the problem—but that’s because a lot of free trade agreements aren’t really about free trade. Many trade agreements, especially the infamous TRIPS accord, were primarily about restricting trade—specifically on “intellectual property” goods like patented drugs and copyrighted books. They were about expanding the monopoly power of corporations over their products so that the monopoly applied not just to the United States, but indeed to the whole world. This is the opposite of free trade and everything that it stands for. The TPP was a mixed bag, with some genuinely free-trade provisions (removing tariffs on imported cars) and some awful anti-trade provisions (making patents on drugs even stronger).

Every product we buy as an import is another product we sell as an export. This is not quite true, as the US does run a trade deficit; but our trade deficit is small compared to our overall volume of trade (which is ludicrously huge). Total US exports for 2014, the last full year we’ve fully tabulated, were $3.306 trillion—roughly the entire budget of the federal government. Total US imports for 2014 were $3.578 trillion. This makes our trade deficit $272 billion, which is 7.6% of our imports, or about 1.5% of our GDP of $18.148 trillion. So to be more precise, every 100 products we buy as imports are 92 products we sell as exports.

If we stopped making all these imports, what would happen? Well, for one thing, millions of people in China would lose their jobs and fall back into poverty. But even if you’re just looking at the US specifically, there’s no reason to think that domestic production would increase nearly as much as the volume of trade was reduced, because the whole point of trade is that it’s more efficient than domestic production alone. It is actually generous to think that by switching to autarky we’d have even half the domestic production that we’re currently buying in imports. And then of course countries we export to would retaliate, and we’d lose all those exports. The net effect of cutting ourselves off from world trade would be a loss of about $1.5 trillion in GDP—average income would drop by 8%.

Now, to be fair, there are winners and losers. Offshoring of manufacturing does destroy the manufacturing jobs that are offshored; but at least when done properly, it also creates new jobs by improved efficiency. These two effects are about the same size, so the overall effect is a small decline in the overall number of US manufacturing jobs. It’s not nearly large enough to account for the collapsing middle class.

Globalization may be one contributor to rising inequality, as may changes in technology that make some workers (software programmers) wildly more productive as they make other workers (cashiers, machinists, and soon truck drivers) obsolete. But those of us who have looked carefully at the causes of rising income inequality know that this is at best a small part of what’s really going on.

The real cause is what Bernie Sanders is always on about: The 1%. Gains in income in the US for the last few decades (roughly as long as I’ve been alive) have been concentrated in a very small minority of the population—in fact, even 1% may be too coarse. Most of the income gains have actually gone to more like the top 0.5% or top 0.25%, and the most spectacular increases in income have all been concentrated in the top 0.01%.

The story that we’ve been told—I dare say sold—by the mainstream media (which is, lets face it, owned by a handful of corporations) is that new technology has made it so that anyone who works hard (or at least anyone who is talented and works hard and gets a bit lucky) can succeed or even excel in this new tech-driven economy.

I just gave up on a piece of drivel called Bold that was seriously trying to argue that anyone with a brilliant idea can become a billionaire if they just try hard enough. (It also seemed positively gleeful about the possibility of a cyberpunk dystopia in which corporations use mass surveillance on their customers and competitors—yes, seriously, this was portrayed as a good thing.) If you must read it, please, don’t give these people any more money. Find it in a library, or find a free ebook version, or something. Instead you should give money to the people who wrote the book I switched to, Raw Deal, whose authors actually understand what’s going on here (though I maintain that the book should in fact be called Uber Capitalism).

When you look at where all the money from the tech-driven “new economy” is going, it’s not to the people who actually make things run. A typical wage for a web developer is about $35 per hour, and that’s relatively good as far as entry-level tech jobs. A typical wage for a social media intern is about $11 per hour, which is probably less than what the minimum wage ought to be. The “sharing economy” doesn’t produce outstandingly high incomes for workers, just outstandingly high income risk because you aren’t given a full-time salary. Uber has claimed that its drivers earn $90,000 per year, but in fact their real take-home pay is about $25 per hour. A typical employee at Airbnb makes $28 per hour. If you do manage to find full-time hours at those rates, you can make a middle-class salary; but that’s a big “if”. “Sharing economy”? Robert Reich has aptly renamed it the “share the crumbs economy”.

So where’s all this money going? CEOs. The CEO of Uber has net wealth of $8 billion. The CEO of Airbnb has net wealth of $3.3 billion. But they are paupers compared to the true giants of the tech industry: Larry Page of Google has $36 billion. Jeff Bezos of Amazon has $49 billion. And of course who can forget Bill Gates, founder of Microsoft, and his mind-boggling $77 billion.

Can we seriously believe that this is because their ideas were so brilliant, or because they are so talented and skilled? Uber’s “brilliant” idea is just to monetize carpooling and automate linking people up. Airbnb’s “revolutionary” concept is an app to advertise your bed-and-breakfast. At least Google invented some very impressive search algorithms, Amazon created one of the most competitive product markets in the world, and Microsoft democratized business computing. Of course, none of these would be possible without the invention of the Internet by government and university projects.

As for what these CEOs do that is so skilled? At this point they basically don’t do… anything. Any real work they did was in the past, and now it’s all delegated to other people; they just rake in money because they own things. They can manage if they want, but most of them have figured out that the best CEOs do very little while CEOS who micromanage typically fail. While I can see some argument for the idea that working hard in the past could merit you owning capital in the future, I have a very hard time seeing how being very good at programming and marketing makes you deserve to have so much money you could buy a new Ferrari every day for the rest of your life.

That’s the heuristic I like to tell people, to help them see the absolutely enormous difference between a millionaire and a billionaire: A millionaire is someone who can buy a Ferrari. A billionaire is someone who can buy a new Ferrari every day for the rest of their life. A high double-digit billionaire like Bezos or Gates could buy a new Ferrari every hour for the rest of their life. (Do the math; a Ferrari is about $250,000. Remember that they get a return on capital typically between 5% and 15% per year. With $1 billion, you get $50 to $150 million just in interest and dividends every year, and $100 million is enough to buy 365 Ferraris. As long as you don’t have several very bad years in a row on your stocks, you can keep doing this more or less forever—and that’s with only $1 billion.)

Immigration and globalization are not what is killing the American middle class. Corporatization is what’s killing the American middle class. Specifically, the use of regulatory capture to enforce monopoly power and thereby appropriate almost all the gains of new technologies into into the hands of a few dozen billionaires. Typically this is achieved through intellectual property, since corporate-owned patents basically just are monopolistic regulatory capture.

Since 1984, US real GDP per capita rose from $28,416 to $46,405 (in 2005 dollars). In that same time period, real median household income only rose from $48,664 to $53,657 (in 2014 dollars). That means that the total amount of income per person in the US rose by 49 log points (63%), while the amount of income that a typical family received only rose 10 log points (10%). If median income had risen at the same rate as per-capita GDP (and if inequality remained constant, it would), it would now be over $79,000, instead of $53,657. That is, a typical family would have $25,000 more than they actually do. The poverty line for a family of 4 is $24,300; so if you’re a family of 4 or less, the billionaires owe you a poverty line. You should have three times the poverty line, and in fact you have only two—because they took the rest.

And let me be very clear: I mean took. I mean stole, in a very real sense. This is not wealth that they created by their brilliance and hard work. This is wealth that they expropriated by exploiting people and manipulating the system in their favor. There is no way that the top 1% deserves to have as much wealth as the bottom 95% combined. They may be talented; they may work hard; but they are not that talented, and they do not work that hard. You speak of “confiscation of wealth” and you mean income taxes? No, this is the confiscation of our nation’s wealth.

Those of us who voted for Bernie Sanders voted for someone who is trying to stop it.

Those of you who voted for Donald Trump? Congratulations on supporting someone who epitomizes it.

How Reagan ruined America

pnrj inequality, macroeconomics, public policy , , , , , , , , , , , , , , , , ,

JDN 2457408

Or maybe it’s Ford?

The title is intentionally hyperbolic; despite the best efforts of Reagan and his ilk, America does yet survive. Indeed, as Obama aptly pointed out in his recent State of the Union, we appear to be on an upward trajectory once more. And as you’ll see in a moment, many of the turning points actually seem to be Gerald Ford, though it was under Reagan that the trends really gained steam.

But I think it’s quite remarkable just how much damage Reaganomics did to the economy and society of the United States. It’s actually a turning point in all sorts of different economic policy measures; things were going well from the 1940s to the 1970s, and then suddenly in the 1980s they take a turn for the worse.

The clearest example is inequality. From the World Top Incomes Database, here’s the graph I featured on my Patreon page of income shares in the United States:

top_income_shares_pretty.png

Inequality was really bad during the Roaring Twenties (no surprise to anyone who has read The Great Gatsby), then after the turmoil of the Great Depression, the New Deal, and World War 2, inequality was reduced to a much lower level.

During this period, what I like to call the Golden Age of American Capitalism:

Instead of almost 50% in the 1920s, the top 10% now received about 33%.

Instead of over 20% in the 1920s, the top 1% now received about 10%.

Instead of almost 5% in the 1920s, the top 0.01% now received about 1%.

This pattern continued to hold, remarkably stable, until 1980. Then, it completely unraveled. Income shares of the top brackets rose, and continued to rise, ever since (fluctuating with the stock market of course). Now, we’re basically back right where we were in the 1920s; the top 10% gets 50%, the top 1% gets 20%, and the top 0.01% gets 4%.

Not coincidentally, we see the same pattern if we look at the ratio of CEO pay to average worker pay, as shown here in a graph from the Economic Policy Institute:

Snapshot_CEO_pay_main

Up until 1980, the ratio in pay between CEOs and their average workers was steady around 20 to 1. From that point forward, it began to rise—and rise, and rise. It continued to rise under every Presidential administration, and actually hit its peak in 2000, under Bill Clinton, at an astonishing 411 to 1 ratio. In the 2000s it fell to about 250 to 1 (hurray?), and has slightly declined since then to about 230 to 1.

By either measure, we can see a clear turning point in US inequality—it was low and stable, until Reagan came along, when it began to explode.

Part of this no doubt is the sudden shift in tax rates. The top marginal tax rates on income were over 90% from WW2 to the 1960s; then JFK reduced them to 70%, which is probably close to the revenue-maximizing rate. There they stayed, until—you know the refrain—along came Reagan, and by the end of his administration he had dropped the top marginal rate to 28%. It then was brought back up to about 35%, where it has basically remained, sometimes getting as high as 40%.

US_income_tax_rates

Another striking example is the ratio between worker productivity and wages. The Economic Policy Institute has a very detailed analysis of this, but I think their graph by itself is quite striking:

productivity_wages

Starting around the 1970s, and then rapidly accelerating from the 1980s onward, we see a decoupling of productivity from wages. Productivity has continued to rise at more or less the same rate, but wages flatten out completely, even falling for part of the period.

For those who still somehow think Republicans are fiscally conservative, take a look at this graph of the US national debt:

US_federal_debt

We were at a comfortable 30-40% of GDP range, actually slowly decreasing—until Reagan. We got back on track to reduce the debt during the mid-1990s—under Bill Clinton—and then went back to raising it again once George W. Bush got in office. It ballooned as a result of the Great Recession, and for the past few years Obama has been trying to bring it back under control.

Of course, national debt is not nearly as bad as most people imagine it to be. If Reagan had only raised the national debt in order to stop unemployment, that would have been fine—but he did not.

Unemployment had never been above 10% since World War 2 (and in fact reached below 4% in the 1960s!) and yet all the sudden hit almost 11%, shortly after Reagan:
US_unemployment
Let’s look at that graph a little closer. Right now the Federal Reserve uses 5% as their target unemployment rate, the supposed “natural rate of unemployment” (a lot of economists use this notion, despite there being almost no empirical support for it whatsoever). If I draw red lines at 5% unemployment and at 1981, the year Reagan took office, look at what happens.

US_unemployment_annotated

For most of the period before 1981, we spent most of our time below the 5% line, jumping above it during recessions and then coming back down; for most of the period after 1981, we spent most of our time above the 5% line, even during economic booms.

I’ve drawn another line (green) where the most natural break appears, and it actually seems to be the Ford administration; so maybe I can’t just blame Reagan. But something happened in the last quarter of the 20th century that dramatically changed the shape of unemployment in America.

Inflation is at least ambiguous; it was pretty bad in the 1940s and 1950s, and then settled down in the 1960s for awhile before picking up in the 1970s, and actually hit its worst just before Reagan took office:

US_inflation

Then there’s GDP growth.

US_GDP_growth

After World War 2, our growth rate was quite volatile, rising as high as 8% (!) in some years, but sometimes falling to zero or slightly negative. Rates over 6% were common during booms. On average GDP growth was quite good, around 4% per year.

In 1981—the year Reagan took office—we had the worst growth rate in postwar history, an awful -1.9%. Coming out of that recession we had very high growth of about 7%, but then settled into the new normal: More stable growth rates, yes, but also much lower. Never again did our growth rate exceed 4%, and on average it was more like 2%. In 2009, Reagan’s record recession was broken with the Great Recession, a drop of almost 3% in a single year.

GDP per capita tells a similar story, of volatile but fast growth before Reagan followed by stable but slow growth thereafter:

US_GDP_per_capita

Of course, it wouldn’t be fair to blame Reagan for all of this. A lot of things have happened in the late 20th century, after all. In particular, the OPEC oil crisis is probably responsible for many of these 1970s shocks, and when Nixon moved us at last off the Bretton Woods gold standard, it was probably the right decision, but done at a moment of crisis instead of as the result of careful planning.

Also, while the classical gold standard was terrible, the Bretton Woods system actually had some things to recommend it. It required strict capital controls and currency exchange regulations, but the period of highest economic growth and lowest inequality in the United States—the period I’m calling the Golden Age of American Capitalism—was in fact the same period as the Bretton Woods system.

Some of these trends started before Reagan, and all of them continued in his absence—many of them worsening as much or more under Clinton. Reagan took office during a terrible recession, and either contributed to the recovery or at least did not prevent it.

The President only has very limited control over the economy in any case; he can set a policy agenda, but Congress must actually implement it, and policy can take years to show its true effects. Yet given Reagan’s agenda of cutting top tax rates, crushing unions, and generally giving large corporations whatever they want, I think he bears at least some responsibility for turning our economy in this very bad direction.

The winner-takes-all effect

pnrj market failure, Top 10 things to know about economics , , , , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457054 PST 14:06.

As I write there is some sort of mariachi band playing on my front lawn. It is actually rather odd that I have a front lawn, since my apartment is set back from the road; yet there is the patch of grass, and there is the band playing upon it. This sort of thing is part of the excitement of living in a large city (and Long Beach would seem like a large city were it not right next to the sprawling immensity that is Los Angeles—there are more people in Long Beach than in Cleveland, but there are more people in greater Los Angeles than in Sweden); with a certain critical mass of human beings comes unexpected pieces of culture.

The fact that people agglomerate in this way is actually relevant to today’s topic, which is what I will call the winner-takes-all effect. I actually just finished reading a book called The Winner-Take-All Society, which is particularly horrifying to read because it came out in 1996. That’s almost twenty years ago, and things were already bad; and since then everything it describes has only gotten worse.

What is the winner-takes-all effect? It is the simple fact that in competitive capitalist markets, a small difference in quality can yield an enormous difference in return. The third most popular soda drink company probably still makes drinks that are pretty good, but do you have any idea what it is? There’s Coke, there’s Pepsi, and then there’s… uh… Dr. Pepper, apparently! But I didn’t know that before today and I bet you didn’t either. Now think about what it must be like to be the 15th most popular soda drink company, or the 37th. That’s the winner-takes-all effect.

I don’t generally follow football, but since tomorrow is the Super Bowl I feel some obligation to use that example as well. The highest-paid quarterback is Russell Wilson of the Seattle Seahawks, who is signing onto a five-year contract worth $110 million ($22 million a year). In annual income that will make him pass Jay Cutler of the Chicago Bears who has a seven-year contract worth $127 million ($18.5 million a year). This shift may have something to do with the fact that the Seahawks are in the Super Bowl this year and the Bears are not (they haven’t since 2007). Now consider what life is like for most football players; the median income of football players is most likely zero (at least as far as football-related income), and the median income of NFL players—the cream of the crop already—is $770,000; that’s still very good money of course (more than Krugman makes, actually! But he could make more, if he were willing to sell out to Wall Street), but it’s barely 1/30 of what Wilson is going to be making. To make that million-dollar salary, you need to be the best, of the best, of the best (sir!). That’s the winner-takes-all effect.

To go back to the example of cities, it is for similar reasons that the largest cities (New York, Los Angeles, London, Tokyo, Shanghai, Hong Kong, Delhi) become packed with tens of millions of people while others (Long Beach, Ann Arbor, Cleveland) get hundreds of thousands and most (Petoskey, Ketchikan, Heber City, and hundreds of others you’ve never heard of) get only a few thousand. Beyond that there are thousands of tiny little hamlets that many don’t even consider cities. The median city probably has about 10,000 people in it, and that only because we’d stop calling it a city if it fell below 1,000. If we include every tiny little village, the median town size is probably about 20 people. Meanwhile the largest city in the world is Tokyo, with a greater metropolitan area that holds almost 38 million people—or to put it another way almost exactly as many people as California. Huh, LA doesn’t seem so big now does it? How big is a typical town? Well, that’s the thing about this sort of power-law distribution; the concept of “typical” or “average” doesn’t really apply anymore. Each little piece of the distribution has basically the same shape as the whole distribution, so there isn’t a “typical” size or scale. That’s the winner-takes-all effect.

As they freely admit in the book, it isn’t literally that a single winner takes everything. That is the theoretical maximum level of wealth inequality, and fortunately no society has ever quite reached it. The closest we get in today’s society is probably Saudi Arabia, which recently lost its king—and yes I do mean king in the fullest sense of the word, a man of virtually unlimited riches and near-absolute power. His net wealth was estimated at $18 billion, which frankly sounds low; still even if that’s half the true amount it’s oddly comforting to know that he is still not quite as rich as Bill Gates ($78 billion), who earned his wealth at least semi-legitimately in a basically free society. Say what you will about intellectual property rents and market manipulation—and you know I do—but they are worlds away from what Abdullah’s family did, which was literally and directly robbed from millions of people by the power of the sword. Mostly he just inherited all that, and he did implement some minor reforms, but make no mistake: He was ruthless and by no means willing to give up his absolute power—he beheaded dozens of political dissidents, for example. Saudi Arabia does spread their wealth around a little, such that basically no one is below the UN poverty lines of $1.25 and $2 per day, but about a fourth of the population is below the national poverty line—which is just about the same distribution of wealth as what we have in the US, which actually makes me wonder just how free and legitimate our markets really are.

The winner-takes-all effect would really be more accurately described as the “top small fraction takes the vast majority” effect, but that isn’t nearly as catchy, now is it?

There are several different causes that can all lead to this same result. In the book, Robert Frank and Philip Cook argue that we should not attribute the cause to market manipulation, but in fact to the natural functioning of competitive markets. There’s something to be said for this—I used to buy the whole idea that competitive markets are the best, but increasingly I’ve been seeing ways that less competitive markets can make better overall outcomes.

Where they lose me is in arguing that the skyrocketing compensation packages for CEOs are due to their superior performance, and corporations are just being rational in competing for the best CEOs. If that were true, we wouldn’t find that the rank correlation between the CEO’s pay and the company’s stock performance is statistically indistinguishable from zero. Actually even a small positive correlation wouldn’t prove that the CEOs are actually performing well; it could just be that companies that perform well are willing to pay their CEOs more—and stock option compensation will do this automatically. But in fact the correlation is so tiny as to be negligible; corporations would be better off hiring a random person off the street and paying them $50,000 for all the CEO does for their stock performance. If you adjust for the size of the company, you find that having a higher-paid CEO is positively related to performance for small startups, but negatively correlated for large well-established corporations. No, clearly there’s something going on here besides competitive pay for high performance—corruption comes to mind, which you’ll remember was the subject of my master’s thesis.

But in some cases there isn’t any apparent corruption, and yet we still see these enormously unequal distributions of income. Another good example of this is the publishing industry, in which J.K. Rowling can make over $1 billion (she donated enough to charity to officially lose her billionaire status) but most authors make little or nothing, particularly those who can’t get published in the first place. I have no reason to believe that J.K. Rowling acquired this massive wealth by corruption; she just sold an awful lot of books—over 100 million of the first Harry Potter book alone.

But why would she be able to sell 100 million while thousands of authors write books that are probably just as good or nearly so make nothing? Am I just bitter and envious, as Mitt Romney would say? Is J.K. Rowling actually a million times as good an author as I am?

Obviously not, right? She may be better, but she’s not that much better. So how is it that she ends up making a million times as much as I do from writing? It feels like squaring the circle: How can markets be efficient and competitive, yet some people are being paid millions of times as others despite being only slightly more productive?

The answer is simple but enormously powerful: positive feedback.Once you start doing well, it’s easier to do better. You have what economists call an economy of scale. The first 10,000 books sold is the hardest; then the next 10,000 is a little easier; the next 10,000 a little easier still. In fact I suspect that in many cases the first 10% growth is harder than the second 10% growth and so on—which is actually a much stronger claim. For my sales to grow 10% I’d need to add like 20 people. For J.K. Rowling’s sales to grow 10% she’d need to add 10 million. Yet it might actually be easier for J.K. Rowling to add 10 million than for me to add 20. If not, it isn’t much harder. Suppose we tried by just sending out enticing tweets. I have about 100 Twitter followers, so I’d need 0.2 sales per follower; she has about 4 million, so she’d need an average of 2.5 sales per follower. That’s an advantage for me, percentage-wise—but if we have the same uptake rate I sell 20 books and she sells 800,000.

If you have only a handful of book sales like I do, those sales are static; but once you cross that line into millions of sales, it’s easy for that to spread into tens or even hundreds of millions. In the particular case of books, this is because it spreads by word-of-mouth; say each person who reads a book recommends it to 10 friends, and you only read a book if at least 2 of your friends recommended it. In a city of 100,000 people, if you start with 50 people reading it, odds are that most of those people don’t have friends that overlap and so you stop at 50. But if you start at 50,000, there is bound to be a great deal of overlap; so then that 50,000 recruits another 10,000, then another 10,000, and pretty soon the whole 100,000 have read it. In this case we have what are called network externalities—you’re more likely to read a book if your friends have read it, so the more people there are who have read it, the more people there are who want to read it. There’s a very similar effect at work in social networks; why does everyone still use Facebook, even though it’s actually pretty awful? Because everyone uses Facebook. Less important than the quality of the software platform (Google Plus is better, and there are some third-party networks that are likely better still) is the fact that all your friends and family are on it. We all use Facebook because we all use Facebook? We all read Harry Potter books because we all read Harry Potter books? The first rule of tautology club is…

Languages are also like this, which is why I can write this post in English and yet people can still read it around the world. English is the winner of the language competition (we call it the lingua franca, as weird as that is—French is not the lingua franca anymore). The losers are those hundreds of New Guinean languages you’ve never heard of, many of which are dying. And their distribution obeys, once again, a power-law. (Individual words actually obey a power-law as well, which makes this whole fractal business delightfully ever more so.)
Network externalities are not the only way that the winner-takes-all effect can occur, though I think it is the most common. You can also have economies of scale from the supply side, particularly in the case of information: Recording a song is a lot of time and effort, but once you record a song, it’s trivial to make more copies of it. So that first recording costs a great deal, while every subsequent recording costs next to nothing. This is probably also at work in the case of J.K. Rowling and the NFL; the two phenomena are by no means mutually exclusive. But clearly the sizes of cities are due to network externalities: It’s quite expensive to live in a big city—no supply-side economy of scale—but you want to live in a city where other people live because that’s where friends and family and opportunities are.

The most worrisome kind of winner-takes-all effect is what Frank and Cook call deep pockets: Once you have concentration of wealth in a few hands, those few individuals can now choose their own winners in a much more literal sense: the rich can commission works of art from their favorite artists, exacerbating the inequality among artists; worse yet they can use their money to influence politicians (as the Kochs are planning on spending $900 million—$3 for every person in America—to do in 2016) and exacerbate the inequality in the whole system. That gives us even more positive feedback on top of all the other positive feedbacks.

Sure enough, if you run the standard neoclassical economic models of competition and just insert the assumption of economies of scale, the result is concentration of wealth—in fact, if nothing about the rules prevents it, the result is a complete monopoly. Nor is this result in any sense economically efficient; it’s just what naturally happens in the presence of economies of scale.

Frank and Cook seem most concerned about the fact that these winner-take-all incomes will tend to push too many people to seek those careers, leaving millions of would-be artists, musicians and quarterbacks with dashed dreams when they might have been perfectly happy as electrical engineers or high school teachers. While this may be true—next week I’ll go into detail about prospect theory and why human beings are terrible at making judgments based on probability—it isn’t really what I’m most concerned about. For all the cost of frustrated ambition there is also a good deal of benefit; striving for greatness does not just make the world better if we succeed, it can make ourselves better even if we fail. I’d strongly encourage people to have backup plans; but I’m not going to tell people to stop painting, singing, writing, or playing football just because they’re unlikely to make a living at it. The one concern I do have is that the competition is so fierce that we are pressured to go all in, to not have backup plans, to use performance-enhancing drugs—they may carry awful risks, but they also work. And it’s probably true, actually, that you’re a bit more likely to make it all the way to the top if you don’t have a backup plan. You’re also vastly more likely to end up at the bottom. Is raising your probability of being a bestselling author from 0.00011% to 0.00012% worth giving up all other career options? Skipping chemistry class to practice football may improve your chances of being an NFL quarterback from 0.000013% to 0.000014%, but it will also drop your chances of being a chemical engineer from 95% (a degree in chemical engineering almost guarantees you a job eventually) to more like 5% (it’s hard to get a degree when you flunk all your classes).

Frank and Cook offer a solution that I think is basically right; they call it positional arms control agreements. By analogy with arms control agreements between nations—and what is war, if not the ultimate winner-takes-all contest?—they propose that we use taxation and regulation policy to provide incentives to make people compete less fiercely for the top positions. Some of these we already do: Performance-enhancing drugs are banned in professional sports, for instance. Even where there are no regulations, we can use social norms: That’s why it’s actually a good thing that your parents rarely support your decision to drop out of school and become a movie star.

That’s yet another reason why progressive taxation is a good idea, as if we needed another; by paring down those top incomes it makes the prospect of winning big less enticing. If NFL quarterbacks only made 10 times what chemical engineers make instead of 300 times, people would be a lot more hesitant to give up on chemical engineering to become a quarterback. If top Wall Street executives only made 50 times what normal people make instead of 5000, people with physics degrees might go back to actually being physicists instead of speculating on stock markets.

There is one case where we might not want fewer people to try, and that is entrepreneurship. Most startups fail, and only a handful go on to make mind-bogglingly huge amounts of money (often for no apparent reason, like the Snuggie and Flappy Bird), yet entrepreneurship is what drives the dynamism of a capitalist economy. We need people to start new businesses, and right now they do that mainly because of a tiny chance of a huge benefit. Yet we don’t want them to be too unrealistic in their expectations: Entrepreneurs are much more optimistic than the general population, but the most successful entrepreneurs are a bit less optimistic than other entrepreneurs. The most successful strategy is to be optimistic but realistic; this outperforms both unrealistic optimism and pessimism. That seems pretty intuitive; you have to be confident you’ll succeed, but you can’t be totally delusional. Yet it’s precisely the realistic optimists who are most likely to be disincentivized by a reduction in the top prizes.

Here’s my solution: Let’s change it from a tiny change of a huge benefit to a large chance of a moderately large benefit. Let’s reward entrepreneurs for trying—with standards for what constitutes a really serious, good attempt rather than something frivolous that was guaranteed to fail. Use part of the funds from the progressive tax as a fund for angel grants, provided to a large number of the most promising entrepreneurs. It can’t be a million-dollar prize for the top 100. It needs to be more like a $50,000 prize for the top 100,000 (which would cost $5 billion a year, affordable for the US government). It should be paid at the proposal phase; the top 100,000 business plans receive the funding and are under no obligation to repay it. It has to be enough money that someone can rationally commit themselves to years of dedicated work without throwing themselves into poverty, and it has to be confirmed money so that they don’t have to worry about throwing themselves into debt. As for the upper limit, it only needs to be small enough that there is still an incentive for the business to succeed; but even with a 99% tax Mark Zuckerberg would still be a millionaire, so the rewards for success are high indeed.

The good news is that we actually have such a system to some extent. For research scientists rather than entrepreneurs, NSF grants are pretty close to what I have in mind, but at present they are a bit too competitive: 8,000 research grants with a median of $130,000 each and a 20% acceptance rate isn’t quite enough people—the acceptance rate should be higher, since most of these proposals are quite worthy. Still, it’s close, and definitely a much better incentive system than what we have for entrepreneurs; there are almost 12 million entrepreneurs in the United States, starting 6 million businesses a year, 75% of which fail before they can return their venture capital. Those that succeed have incomes higher than the general population, with a median income of around $70,000 per year, but most of this is accounted for by the fact that entrepreneurs are more educated and talented than the general population. Once you factor that in, successful entrepreneurs have about 50% more income on average, but their standard deviation of income is also 60% higher—so some are getting a lot and some are getting very little. Since 75% fail, we’re talking about a 25% chance of entering an income distribution that’s higher on average but much more variable, and a 75% chance of going through a period with little or no income at all—is it worth it? Maybe, maybe not. But if you could get a guaranteed $50,000 for having a good idea—and let me be clear, only serious proposals that have a good chance of success should qualify—that deal sounds an awful lot better.