Articles, Blog

15. Mass Affluence Comes to the Western World

November 16, 2019

Prof: Okay,
today the coming of mass affluence to the advanced
economies, principally the economies of the west.
Jennifer, speaking of informal
property rights, I thought you owned a chair
right up there? I ‘m just kidding.
I’m going to take it in three
chunks. We’re going to look at big
picture, causal explanations for the
rise of mass affluence, and for explanations first of
its rise, and second, its rise beginning
in Western Europe and North America.
Second, I’m going to
reintroduce the joint stock corporation into that
conversation, and finally we’re going to look
at the phenomenon of mass affluence and the advertising
culture of mid-twentieth century America.
Then on Wednesday we’re going
to descend to details, and the challenge for you in
preparing for Wednesday is to imagine a country,
and imagine that you somehow have been granted a fund
amounting to 5% of its gross domestic product,
and with that 5% you want to make whatever changes you can
imagine, will increase the overall
wealth of that country as much as possible.
It’s a pragmatic question.
It has a causal side to it,
but ultimately it’s pragmatic and it is not one size fits all.
That is, you’ve got to know
something about the country to know something about what needs
doing; 5% of the GDP in Ghana will be
spent–will be wisely spent very differently than 5% of the GDP
in Bolivia or Mexico, or Norway.
So the first of the three
topics is capitalist takeoff. The portrait of this corpulent
and obviously affluent gent is Sir Richard Arkwright,
who was the creator of the most efficient early textile
machinery, and who unlike many others
about whom Clark talks, actually profited very
handsomely from that work. By takeoff in the west,
and this goes back to the first day of class,
and by Wednesday we’ll go back again to and look
at the bubbles moving through space.
This still photograph,
so to speak, covers a longer time horizon,
a 500 year time horizon. It shows an abrupt northward
movement in GDP per capita in the U.S., lagging a bit in
Japan, lagging further in China, India, and Indonesia.
If we just throw all the
countries in the world in a pot, we get a picture that looks
something like this, where gross GDP is in blue,
population in green, and the one divided by the
other in gold. What we’re interested in from
here to the end of term really is in understanding what lies
behind these curves and in thinking about from a given a
country’s point of view, or from given class of people
in a given country’s point of view,
how can we increase the rate at which things gets better?
Now before I go further some of
you are thinking green thoughts. Wave at me if you’re thinking
green thoughts and wondering whether it’s really a good idea;
I have so many people with so much money in their pockets.
Sasha tell us.
We got a microphone here?
Student: I think
basically the root of all environmental problems,
if you care about the natural environment,
is that there are too many people, so you have more people
who can consume more. The simple thing to think is
that that’s bad news for the earth.
Prof: Okay so you would
like to kill off a portion of the world’s population.
Student: Yes.
Prof: Okay very
straightforward, good, clear MBA thinking.
Given a constant world
population, if we had it, would you prefer that that
population on average be a little less affluent then it is,
or that I seem to want it to be? Student: I’m not sure
that it’s that straightforward because if people–
societies don’t have the means to advance technology,
even though consumption does go up,
you have cleaner technologies that would be developed with
greater economic prosperity, so I’m not as clear on that one.
Prof: Okay, not as clear.
Now you would acknowledge that
as hundreds of millions of people living in places like
China and India come into income enough to have a family car or
even two, that there’s a challenge there?
Student: Certainly.
Prof: Okay,
so let’s keep the natural environment in the background as
we talk about this, but let’s for the moment focus
on economics, and let’s start with a curve
like this. The curve shows low income to
the left, high income to the right,
and the frequency of each income stratum is indicated
vertically, and the red curve is a fairly
typical market economy income distribution with a truncated
tail on the left, and an elongated tail on the
right, with the mean income being much
higher than the median because it is pulled to the right by the
very high incomes. If this chart were drawn to
scale that right hand tail would probably be even more elongated,
but wondrously thin out to the right.
Well the phenomenon of takeoff
is the upward shift in that distribution.
It may change shape a little,
bit it’s not mainly that it’s changing shape;
it’s that its mean is drifting upward and to the right.
If we think about two
distributions, two or three generations
removed from one another in a given society,
let’s say the United States 1920 and the United States
today, it will often be the case that
the difference is so dramatic that the material condition of
people living in the top tenth then will be about like the top
half today. And you keep that up for ten
generations or so, and you have something like
this, where the top decile in, let’s say, 1800,
is living in material conditions that would be
equivalent to perhaps the ninth decile today.
Not the very bottom,
but people living relatively near the bottom.
This is particularly true if
you take into account not just income,
but what it is that income can buy in the way of medical care,
comfort and lodging, quality of diet,
and so forth. There’s an enormous explosive
change in the background here. That change is our subject.
Now how you feel about that
change is more complicated and we often hear that money doesn’t
buy happiness. The people who say that have
evidence of a kind. None of them volunteer to
become poor, and there is something that money buys that
people want, and we’ll return to that from time to time.
But imagine now that there
are–just think about an economy with two people in it,
A’s income or wealth is measured vertically,
B’s is measured horizontally, and you’re Mr. A.
Which of these two outcomes
would you prefer on–by one way of thinking you’re maximizing
your own income, you’d like to be there.
If on the other hand,
what you’re doing is staying ahead of the Joneses,
you’d like to be there. More generally,
if you’re just trying to maximize your own household
income, you will have indifference
curves like these horizontal ones and just seek to climb as
high as possible, and you’ll be perfectly content
if others climb at the same rate,
or even a higher rate. On the other hand,
you may be calculating the ratio of your household to other
households that you choose to compare yourself with and the
indifference curve will then become rays from the origin like
that, and you will be trying to swing
your position from bottom right to upper left.
One function is just maximize
one variable and the other is maximize the ratio of two
variables, and most people are–tend to mix these two
things. The–their contentment with
their material position is partly relative and partly
absolute; absolute here, relative there.
If you think about the
employees of a firm, the way they’re compensated
is–raises both concerns. Suppose everybody in a law firm
is making between $150,000 and $200,000, and along comes Jim
Alexander, ace corporate lawyer–
Jim Alexander: Never. Prof: Never, I know.
I’m abusing you.
Never, and–all right Leslie
Hough, ace corporate lawyer,
and we really need her and we’ve got to pay her $800,000
and we make the offer and she takes it.
There will be a–if this fact
becomes public within the firm, which is quite likely,
everybody else will in some measure feel impoverished by it.
She’s making four times what
I’m making; surely she’s not four times
better than me, so the relative and the
absolute are always at play. Now let’s look through Clark’s
explanations–and I spent almost all of yesterday reviewing
Clark, and he’s kind of all over the place.
There’s some of everything in
this book, but let’s pick out some of his
main explanations for economic takeoff,
and for the fact that the takeoff occurred first and most
dramatically in western countries,
and among western countries, first in the United Kingdom.
His–there’s a recurring theme,
it’s in the beginning, the middle, and the end of the
book, about his speculative
interpretation of wills from England in late medieval and
early modern– and right into modern times.
The phenomenon he finds is a
fountain of wellborn children who cannot replicate their
parents place in society. The empirics on this are pretty
strong. That well to do families,
by and large, had more than two surviving
children reaching– more than two children reaching
adulthood, and indeed, the survival rate
among well to do children was quite a lot higher than the
survival rate among other children.
If you read all the way to the
end of the book you discover that if you compare this with
Asian societies such as Japan and China,
the effect is stronger in England.
From this he adduces several
consequences, the most obvious of which is
that many of these wellborn children will be downward
mobiles. The will marry beneath their
class, they will take up occupations
or roles beneath their parents’ class,
and Clark is–he’s trying to say two things at once.
One is that the culture–the
universalization of culture from the top could in some measure be
promoted by this downward mobility;
that children raised with high expectations and upbringing may
be cultural carriers which would infuse lower economic strata
with a more energetic, more performance-oriented
outlook. For that there’s no evidence in
this story, it’s just a speculation.
The other speculation,
for which there is also no specific evidence,
is a Darwinian genetics story in which–
and here Clark is–this is dangerous territory in the way
of politics. He seems to believe that the
genes carried at the top of the income curve may be better genes
than those elsewhere in the income curve,
and that the downward–forced downward mobility of progeny
from that top level gene pool might upgrade the whole society
in a genetic sense. Anybody want to comment on that
thought? Yes.
Student: I mean,
genetically speaking it’s just sort of silly,
because traits don’t pass directly.
You aren’t a clone of your
parents, or even just a 50/50 combo.
In terms of carrying skills
downward though, I mean that makes a lot of
sense. If you’re well educated and you
bring that down you might educate your children,
values, etc. Prof: That’s precisely
my own view, but does anybody want to defend Clark here?
Student: Well it could
be more of a bell curve situation, if you know what I
mean. The people on the higher end of
the income ladder have, over time, been privy to better
situations and better selection pressures leading to the
evolution of skills like analytical thinking,
intelligence skills that are necessary for the professions
that are characteristic of the higher classes.
Prof: Let’s have a vote
here. How many people think it’s
likely that there is some validity to–let’s start with
the cultural story and then go to the genetic story.
How many people find the
cultural story broadly plausible?
The opposite–implausible?
Okay, and how many find the
genetics story broadly plausible?
Fewer, but a substantial number.
And how many find it
implausible? Okay, I have no idea,
and Clark provides not one shred of evidence with which we
could test this. My own guess is that a few
hundred years is a pretty short time for carrying out the kind
of selection process he has in mind.
It’s also the case that the
association between parental–let’s call it IQ.
The twin studies actually do
confirm this– where identical twins are born
to Mr. and Mrs. Smith and raised by
Mr. and Mrs. Jones,
in IQ and several other variables, the association
between the identical will be greater than between them and
the siblings belonging to the new family,
so genetics is not wholly out of the picture.
On the other hand,
from a pragmatic point of view, which is where we’re going with
all this, the idea of–well what was Eugenics?
Does anybody–are any of you in
a history course, picked up Eugenics?
Student: Eugenics is an
idea that in some form has existed since ancient times,
but really picked up in the late nineteenth century,
and then especially under the Third Reich,
where it was essentially believed that people at the top
tended to have better genes, or in the case of the Third
Reich, a specific racial group, and therefore you want to
maximize the number of people with certain desirable traits
for reproducing, and minimize the ability of
people with undesirable traits to reproduce,
resulting in a better, stronger, smarter,
in the case of the Nazis, blonder, race.
Prof: Okay,
that’s the gist of it. The heart of it,
which was most influential, had to do with trying to
prevent people who were mentally retarded from reproducing,
and a lot of that happened. The vulgar prejudices that lay
behind much of it, it was–much of it was
conducted by something called The Vineland Institute,
located near Princeton, New Jersey;
no guilt by association there. The Vineland Institute
published data showing that all the immigrant groups streaming
into the U.S. in the early twentieth century
were inferior to WASPS mentally, and they were very tough on the
Jews. The Jews are just not bright at
all, and they did this by administering English language
questionnaires to immigrants just after they got here.
The pragmatics of culture are
something that’s a lot easier to deal with, and which fits more
readily into the humanistic framework that we share.
After “the fountain,”
which really doesn’t fit into any of his categories,
Clark has three broad categories.
One is exogenous growth
theories–exogenous meaning economic growth caused by
something that is–that has its origin outside of the market
economy. One of these ideas,
which I think he’s right about, he doesn’t run with it very
far, but the emergence of the nation’s state system,
the rule of law, the existence of well
formalized property rights, all that stuff is pretty
powerful, and the western world was the initial focal point of
the Westphalian nation state system.
Clark is at pains to show that
that by itself isn’t enough an explanation.
In general, no one should
expect one story to explain the evolution of capitalist wealth.
This is way too complex a
story–way to complex a phenomenon for simple theories
to carry the day. A special case of that would be
wealth-maximizing law as illustrated a week ago in
Ghen v. Rich or in U.S.
Cosby, or any of hundreds
of legal precedence. Clark also briefly,
toward the end of the book, takes up the work of a guy
named Kenneth Pomeranz, and Pomeranz has a book called
The Great Divergence which asks the question,
why did the–well he begins with the proposition that from a
social and economic point of view,
China and Japan, both look a lot like Europe in
about 1800. There’s lots to quibble with in
that generalization but it’s not crazy.
Then he says,
“Well, Europe takes off well over a century ahead of
those Asian countries,” and he wants to know why.
His thesis is it has to do with
natural resources. In particular,
that large population centers like the cities of England were
located close to large energy resources such as the coal
mining areas of the Midlands in the United Kingdom.
Also of almost equal importance
for Pomeranz, access to vast agricultural
land in the form of North America,
and that about 1800 was the time when the exploitation of
the largely empty continent in the United States was feeding
resources into Western Europe. There’s some plausibility in
those ideas. Then Clark talks about multiple
equilibrium theories, and the idea here is–think of
time passing that way, and standard of living or
productivity going this way. The idea is that a country
could climb this small hill and get stuck here,
and then there would be some exogenous shock,
some huge event outside the economic system,
which would allow it to pass from that equilibrium to a new
equilibrium on top of the taller hill.
The world demographic
transition is such a story, and not a crazy story at all.
The notion that the falling
death rate created by better public health,
probably more than any single factor,
by clean water, and elementary vaccinations,
but clean water probably above all else,
and the eventual adjustment of the birthrate to that so that
you go from high birthrate, high death rate,
short lives, to low birthrate,
low death rate, long lives. That by itself is a–is I think
without question a powerful element in the story wherever a
nation state society has gone from poor to rich.
Then the endogenous growth
theories, and these are–the idea here is
that something happens inside the economy that creates a
dynamic change, and that dynamic change leads
to mass affluence. I think there’s a lot in this
idea which of course is not Clark’s.
Clark is merely cataloguing
other people’s ideas. The–does anybody recognize
either of these two handsome gentlemen?
I’d prefer the haircut on the
left. This is Joseph Schumpeter,
and this is F.A. Hayek. Each of them had an idea of
about market societies that has to be central to our thinking.
In Schumpeter’s case it was
creative destruction, and I’m told by the teaching
fellows that most of you knew that quite well on the mid-term.
Creative destruction is a way
of reshuffling the deck economically at short intervals,
so that, looking back at this story,
so that sitting still on this hill,
is difficult for any given firm and arguably impossible for
society at large once you’re into a capitalist market
economy. One way to diagram that
is–this diagram we have, the capital invested in a given
kind of product or production, rising from left to right,
and the productivity of that capital rising from bottom to
top, and each of these curves is a
production function representing a technology and a way of
organizing people and handling information.
The idea would be that change
occurs in the sequence 1, 2,3, 4,5, 6 here where there’s
a process of climbing to the right as we go to more
capital-intensive production, more capital per worker,
and then while Tal is doing that,
Jennifer is saying, “Well no,
we should reorganize this entirely.
We should use a different
technology, a different method of
attracting investments, a different method of
compensating employees,” and she shifts to the lower end
of three and then that gets carried to here,
and then a similar shift to the blue production function and
then up that, and so a kind of zigzag story
of change where people compete not within one production
function but between production functions and a chaotic pattern
of creative destruction occurs. What makes it creative is that
it is ultimately an upward movement in productivity.
A version of that story is in
Clark but he doesn’t really think in the dynamic way that
Schumpeter and Hayek, and others do.
Hayek’s story is the one about
the creative potential of a free society,
which I think you had a memo to write about,
and the notion there is that social learning will accrue.
That the society at large will
have a higher learning rate than any individual within it,
and that as each of us goes about her or his work,
we are spewing off insights for others.
Both when we succeed and when
we fail. When we succeed people will
copy our ideas. When we fail people will know
an idea not to try, and that over time society
actually smartens up. If you look at the first
chapter in the assignment for today in Clark,
he has all the factors of growth, as he conceives them,
in a very simplified model, and the residual–
the residual, which accounts for about half
the variance, it’s most natural
interpretation is it is social learning.
It isn’t the specific capital
embodied in a given workers education,
or in the factory plant and equipment with which that worker
is supplied by an employer, but in the less tangible forms
of social knowledge which the society is generating.
And Hayek’s idea,
then, is that over time social learning makes the whole system
smarter, taken as a whole,
and that learning to navigate unfamiliar information,
which arguably, would be something you’re all
doing right now, becomes not only an advantage
to the individual but to the society at large.
Well the most glaring omission
in Clark, in talking about the surge of wealth in the west,
is the joint stock corporation. The joint stock corporation
goes back of course many centuries,
but the kind of joint stock corporation which has become
dominant in the world, goes back only to about the
middle of the 1800s. In the UK it’s dated to The
Corporation Act of 1862, in the U.S.
I think you’d probably say
somewhere in the 1840s it becomes important.
You can find legal traces of it
much earlier in both cases, but it gets to be a big deal in
the middle years of the nineteenth century.
As we saw with the reading from
Alfred Chandler, the rise of the large-scale
railroad in the U.S. provoked the creation of the
equity and bond markets in New York,
and the feverish development of joint stock corporations in
virtually every field of endeavor thereafter.
These slides–I’m going to show
a series of proprietary slides constructed by Ibbotson
Associates. Ibbotson Associates is named
for Roger Ibbotson at The School of Management here.
Ibbotson became filthy rich by
being the first one to systematically compile,
analyze, and sell long trend data about stocks and bonds.
It’s only because he likes to
teach that he bothers to continue.
The time scale here is 1925 to
more or less the present. The earnings of various classes
of assets are– I’ve traced here,
beginning in this case with treasury bills issued by the
government, and as safe as the government
is. Then municipal bonds,
government bonds of other kinds,
corporate bonds, so this would be debt taken on
by a corporation and it might be–
they might be junk bonds if the corporation is a little risky
and they might be blue chip bonds if not.
Then this is–the blue curve is
an amalgam of stock returns, and in every case we start with
$1 in 1925 and keep investing the money–
the way these charts are generated is we assume that
every dollar of dividend is plowed back,
and that we don’t pay any taxes. This would sort of be Yale that
we’re charting. You and I wouldn’t quite have
the same tax privilege Yale has, and the most striking thing
there is–what’s the most striking thing about that chart?
First of all there is some
magic in compound interest, right?
You can just leave your money
to grow, it really does eventually do that.
How about the blue curve versus
the others? Pretty startling–we’ve got to
get somebody else–yes Tal. Student: There seems to
be a rather large equity premium.
What I mean by that is that
there seems to be excess returns if you put your money in stocks
versus any of the other categories,
treasuries, corporate bonds. I mean, you’re obviously taking
on more risk in stocks versus the other categories,
certainly more than treasury bills,
but you could possibly argue that the difference in risk
doesn’t seem as great as a difference in returns over the
long run. Prof: Okay.
What’s the–the equity premium
is the punch line here, well said.
What’s the standard way one
might manage the risk of a portfolio?
Student: You could
diversify. Prof: Okay,
so we wouldn’t put all our money in mining stocks or in–
even in Apple, which is right now one of the
most expensive stocks in the universe,
but the equity premium is huge. Look here what happens–this is
1925, the Depression is here, the great crash is here,
these people got jolted. Of course the temptation when
that happens to you is to imagine that it’s going to go
right to the middle of the earth,
and therefore to sell at this point,
which lots and lots of people did, and of course the effect
was to ruin their wealth. Let’s take another set of these.
We let inflation go unnoticed
in that one and here we’ll show inflation by the red curve,
and then the T-Bills, government bonds,
large company stocks, small company stocks and you
get a huge premium there. Now the–back to the question
of the accumulation of mass affluence;
the power of large enterprise to generate enormous wealth over
long periods; this is a seventy-five,
eighty, eighty-five year period we’re looking at,
but patient–money patiently invested in joint stock
corporations is a solid strategy for the accumulation of wealth
within a given household or institutional portfolio.
It’s not anywhere near the
sexiest or the fastest way, but it is one of the most solid
ways, and the only conclusion I want
to get out of this is that in talking about economic takeoff
and the sustained growth in mass affluence,
companies, joint stock companies with limited
liability, are a big part of that.
Third and last.
With–remember the variable
here is gross domestic product per capita.
Part of that has to do with the
propensity to consume. In the Posner book about what
went wrong with the mortgage markets,
Keynes, Lord Keynes is mentioned, and Keynesian
economics, which are directed to the
question of stabilizing mass demand for products so that the
economy keeps going around and around,
is an important element. Well the joint stock
corporation was, from its birth,
really good at selling. The move, which would be called
forward integration, were not just going to make
cigarettes, we’re going to sell cigarettes.
We’re not just going to make
soap; we’re going to sell soap.
We’re not just going to make
cars; we’re going to sell them.
That forward integration–I’m
going to without comment now just show you 20 slides from the
middle decades of the twentieth century and then we’ll stop
briefly and segue to next– our next meeting.
Some of these are a little
pernicious. This one is not.
The–a repeated trope is using
products to solve marital problems,
and the large glove compartment on this Mercury will solve the
marital problem between these two.
When my grandfather died and I
was seventeen, I inherited a Mercury from him,
it lasted one year before I crashed it.
“Quiet substance”–a
series of Palmolive’s here. They all have to do with men
and women. Women are the sales target.
Does Palmolive soap exist still?
Does anybody still use it?
That’s pretty nasty stuff right?
This is rouge not soap now.

You get the gist of it.
In the consumer culture that’s
embodied in these, and which is powerfully
represented all around us, we live in a very consumption
oriented culture, is arguably a misleadingly
favorable aspect of wealth. That is, an awful lot–if you
think about those ads and how silly it seems,
with seventy years hindsight, that using Palmolive soap will
save your marriage– I often guess that it didn’t
save a single marriage– that whole angle of kind of the
Hucksterish aspect of a capitalist society,
can give one pause. Now I’d like you to come to
class Wednesday having thought a little about a country and what
5% of its GDP would amount to in dollars,
and if you need to look that up you can Google it.
The easiest Google is CIA
Factbook, but the World Bank will give you the data too.
The World Bank or the WTO,
there are all kinds of organizations that produce these
data. Pick a country and think about
5% and think about how you would deploy the 5% if you wanted to
maximize the expected wealth of that society over,
let’s say, a twenty-year future. The reading is the more policy
oriented part of de Soto, and it should in some ways
guide and support your thinking, although you surely want to
think well beyond de Soto’s framework.
So I’ll see you on Wednesday.

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