Although the entries on this website don’t get nearly as many comments as those
of other bloggers, I do occasionally
get an intelligent note in response to something I write. Such was the case
yesterday evening, when Matthew Rose responded to my piece
on Paul Krugman and Michael Lewis.
After working out that he meant the second law of thermodyamics and not the
first, we then entered into a slightly more substantive exchange via email.
Here it is.
MATTHEW: just as a point of fact, you’re wrong about stock market losses. unless
you’re talking about spectacular bankrupcies, of which we’ve seen fairly few,
investments in stocks don’t disappear. it’s transferred wealth, from the buyer
of a stock to the seller. even if you have a real liquidation, stock holders
still have claims on any remaining assets, although admitedly small ones. but
in general, money adheres to the financial equivalent of the second law of thermodynamics:
it simply doesn’t disappear. the assets you hold can decline in value, but that’s
a different matter altogether.
FELIX: Thanks for the comment, Matthew.
You’re right about investments in stocks not simply disappearing, but
that wasn’t what I was talking about. Let’s consider a stock which I bought
at $30, which rose to $100, and which now trades at $10. My $30 certainly went
straight into the pocket of whomever sold the stock to me. But the newspaper
says that $90 of "value" has been destroyed. Now that $90 was never
transferred from anybody to anybody else: it existed, and then it simply disappeared.
So I don’t understand the distinction you’re drawing between "value disappearing"
on the one hand, and "assets declining in value" on the other. Just
as much value disappears when a stock drops from $40 to $30 as when it drops
from $10 to zero.
MATTHEW: Perhaps I should have been clearer. “Value” is terribly
imprecise. Lewis, if I remember rightly, was countering the argument that somehow
trillions of dollars simply disappeared. That’s patently untrue. As you
said, your $30 is now held by someone else. At some point, the asset you held
had a hypothetical cash value of $100, but the subsequent decline in the stock’s
price to even below the $30 you paid didn’t hurt that initial $30. You
lost out on the hypothetical cash value of that stock because no-one thought
it was worth as much as you. Same with buying a car: resale value immediately
plummets but no-one suggests that billions of dollars are destroyed each year
on the second-hand car market.
You can argue about the “wealth effect” implications, the idea that
you feel you had $100 in cash although you never did. But it seems people are
increasingly poopooing that idea; well, as long as consumer spending holds up,
Let’s say someone bought your stock at $40. You didn’t create $10
in value, although you personally are now $10 wealthier. It was just a transfer
from someone who felt your stock was worth more than you did when you bought
it. Logic works the other way around with a declining stock, too.
I don’t see the significance in pointing out that stock market value has
disappeared. Something that people now think is worth X they once thought was
worth 25X. That’s just basic economics and not particularly nefarious.
People probably lost lots of their own money making bets that, but the actualy
cash money wonga moola didn’t disappear.
FELIX: Yes, you’re right that “actual cash money” didn’t
disappear. But when people say that $7 trillion has been wiped out with the
stock market decline, they’re not talking actual cash money. They’re
just subtracting the market cap of the stock market today from the market cap
of the stock market at its height.
So when Lewis writes this: “About the trillions that have been shaved
off the stock market in the past two and a half years, the more general question
is: from whom did it come and to whom did it go?” he’s being disingenuous.
Those trillions never came from anyone or went to anyone: they existed only
on paper. As you say, stock market value has disappeared, but actual cash money
moolah hasn’t either disappeared or been transferred.
MATTHEW: But those trillions weren’t cut from whole cloth. Someone else
was BUYING your stock at $100 which meant actual wonga was being passed around
at those levels. Then when the market fell, someone was left holding the $100
and someone else was left holding the bag.
FELIX: Only at the very margin. Most technology companies only sold a tiny
proportion of their total equity as stock, and most people who bought it hold
onto it, so only a tiny proportion of that tiny proportion actually got traded.
And most of those trades didn’t happen at the top of the market, so only
a tiny proportion of that tiny proportion of that tiny proportion was “actual
wonga being passed around at those levels”.
So if you had a company with, say, 100 million total shares oustanding, and
they traded at $100 at the top, then it had a market cap of $10 billion. If
those shares are now trading at $10, then Michael Lewis and the New York Times
and even – yes – the Wall Street Journal will talk about $9 billion
of value being lost. But the company only ever sold 20 million shares in its
IPO and subsequent offerings, and most of those are still in lock-up, and most
of the rest are in buy-and-hold investment funds, which means that only 5 million
actual individual shares were ever traded (albeit each one of those 5 million
shares was probably traded many times), and of those 5 million shares probably
only 750,000 were traded anywhere near $100. And of those 750,000 transactions
at or near $100, probably 650,000 were unwound at some point on the way down.
So the number of shares which were bought at $100 and are now still held at
$10 – that is, the sum lost, in total, by people who bought at the top
and never sold – is in fact 100,000 x $90 = $9 million. Which is 0.1%
of the headline “value lost” figure.
MATTHEW: That’s an awful lot of simultaneous assumptions. I’d be
surprised if you could find an example of any public company, other than one
controlled by a family, for example, with two classes of stock, that has so
many oustanding shares and such a tiny float.
It actually doesn’t matter. What we’re describing is the basic functioning
of a market. Not very controversial. Fundamentally, I have greater sympathy
for Lewis’s argument that the 90s in many ways spread the wealth over
a vast swathe of society than I do for Krugman’s circular argument that
rich plutocrats control the national debate to allow themselves to become, err,
FELIX: OK, fine, but even if my assumptions are out by an order of magnitude,
we’re still talking a 100-to-one discrepancy between lost value and lost
And even Lewis doesn’t say that the actual wealth – as in cash –
was spread over a vast swathe of society. At best, it was spread over the class
of mid-level and senior employees of recently-formed technology companies. I
think that Lewis is also making an argument that vast swathes of society are
better off now because of the equity capital which was invested in bandwidth
infrastructure etc, in other words my life is better because of the internet,
even if my income and wealth aren’t any higher. Which is another thing
entirely. The fact is, as Krugman shows, only the very wealthiest in society
really made money out of the 90s boom. But I agree with you that Krugman’s
wrong that it’s the plutocrats who are controlling the national debate.
It’s not just the rich who want to reward the rich: it’s the aspirational
poor and middle-class as well.
MATTHEW: Actually, my one main beef with Krugman is that he didn’t prove
that at all. To do that he needed to tackle two things, which I don’t
think he did. 1) put the increase wealth at the top in context of broader growth
in GDP or per capita income, or whatever and 2) talk about social mobility.
The latter’s much more important, and in fact critical: if Krugman’s
Rich of the late 1990s are different people from the Rich of the late 1980s,
for example, then there’s something far more interesting going. Same at
the bottom end of the register.
FELIX: Krugman on the broader growth in per capita income:
"Over the past 30 years most people have seen only modest salary increases:
the average annual salary in America, expressed in 1998 dollars (that is, adjusted
for inflation), rose from $32,522 in 1970 to $35,864 in 1999. That’s about a
10 percent increase over 29 years — progress, but not much. Over the same period,
however, according to Fortune magazine, the average real annual compensation
of the top 100 C.E.O.’s went from $1.3 million — 39 times the pay of an average
worker — to $37.5 million, more than 1,000 times the pay of ordinary workers."
You’re right he doesn’t talk about social mobility. But don’t
try pretending that Jack Welch’s grandchildren aren’t still going
to have dynastic wealth.
MATTHEW: The comparison doesn’t make any sense. These aren’t the
same people in the same periods. Chances are you’ll find some of those
average salary folks from 1970 in the Rich CEO category today. I don’t
know how much of a factor this is, but the fact that Krugman never addressed
it makes me suspicious. At the very least, there’s more to these numbers
than he ever let on.
Bottom line here is whether you think the increasing difference between the
richest and the poorest matters. I’d argue it doesn’t, for a host
of practical and theoretical reasons, and that’s what we’re really
arguing here I think. That’s a bigger and more fundamental subject that
Krugamn glossed. He’s a very clever man, but I wish he’s quit with
FELIX: OK, I’ve been with you up until this point, but now you’ve
lost me. What about Krugman’s comparison doesn’t make any sense?
He’s comparing apples with apples and oranges with oranges: average pay
and CEO pay thirty years ago and today. The fact that today’s CEOs had
average salaries 30 years ago is completely irrelevant. The CEOs 30 years ago
also had only average salaries 60 years ago. Nobody parachutes straight into
a CEO position: they work their way up there, and all power to them. That doesn’t
mean that they deserve the outsized pay packages they receive, though.
It seems to me now that your response to Krugman is basically “yes, you’re
right about inequality, and it doesn’t matter”. But I’d love
to hear your “host of practical and theoretical reasons” why.
MATTHEW: You can’t compare changes within an economic class, i.e. people
with average salaries, to some other social subset and expect it to make any
sense. What happened to other wealthy non-CEOs after the 1970s? What happened
to the top income bracket as a whole over the same time? Why CEOs? Why not sportstars?
Baseball salaries have gone through a staggering inflation since the introduction
of free-agency in the early 1970s but no-one’s blaming the ills of society
on overly aggressive pitching. It’s just a weasly comparison, that’s
all, that doesn’t really show anything.
Here’s why it might not matter that the difference between the rich and
poor now is greater than the difference between the rich and poor 30 years ago.
–social mobility. There are plenty of studies, and I can dig one up for you
if you like, that show how few people stay within their economic group for more
than a generation. The bottom fifth of society, based on income, is not the
same bottom as it was 30 years ago. Immigration is a big reason behind that,
as social mobility and the fact that the U.S. has been growing in wealth pretty
constantly since WW2. That doesn’t take into account entrenched groups,
such as black urban poor, for example, but it’s a pretty compelling idea
that with constant upward social mobility, increasing wealth becomes a source
of aspiration, not resentment (if that even matters).
–does relative income matter? As long as everyone’s getting richer, do
people care that others are getting even richer? Its not clear to me that there’s
a great deal of that kind of class resentment in the U.S. Note that the 1990s
backlash has mostly come from people who lost money, not against people who
made it. I know that’s a squishy socoiological idea, but it’s important,
especially in this mercantile mecca, and something Krugman never considered.
His conspiracy theory of the plutocrats is too silly an idea to replace that.
–what you going to do about it? Let’s assume you’re right, and
that the same people ove time get richer at the expense of the same people getting
poorer. What you going to do? Super-regressive taxation? Higher estate taxes?
At some point, this argument hinges on whether you’re nozikian or rawlsian.
I’m solidly the former. There’s a lovely chapter in his book talking
explicitly about income equality; he argues that society will always divide
itself based along individual differences and that if you equalized income and
wealth, for example, people would develop other ways to distinguish themseleves,
such as height, or sexual prowess.
FELIX: Krugman’s anticipated you. He himself says that CEO pay is “only
the most spectacular indicator of a broader story” which, yes, includes
sportstars. Michael Jordan is indubitably one of Krugman’s new plutocrats.
The top income bracket is getting a lot richer, whether they’re CEOs,
sportstars, film producers, or whatever. Krugman finds a “C.B.O. study
[which] found that between 1979 and 1997, the after-tax incomes of the top 1
percent of families rose 157 percent, compared with only a 10 percent gain for
families near the middle of the income distribution.” That’s nothing
to do with CEOs per se.
To your points: There’s very little evidence that there’s significantly
more social mobility in the US than there is in Krugman’s beloved Sweden.
(Do please dig up a study which shows otherwise if you think there is one.)
In other words, inequality is not a price you have to pay for social mobility:
the correlation between the two is marginal.
If I point out a social ill, it’s not enough to respond that those harmed
don’t seem to mind. Citizens of the USSR during Stalin’s reign of
terror actually genuinely thought he was a great man. (Weird, but true.) They
might not have bought in to all the communist rhetoric he spouted, but most
of the worst excesses of the era can be placed squarely at the feet of Stalin
personally rather than communist theory. And the populace actually admired Stalin
personally, throughout, even those in the gulag. Now, I’m not saying that
a welfare mother who says that welfare ought to be abolished is in the same
situation as any of Stalin’s victims. I’m just saying that whether
or not people are harmed by inequality is something which we ought to be able
to measure objectively, rather than by resorting to opinion polling. And if
you measure things like infant mortality and literacy rates in the US, it comes
bottom among OECD nations. That’s a bad thing, and it can be chalked up,
at least partially, to inequality and the fact that the rich don’t look
after the poor.
As for what one can do about it, one can at the very least try not to exacerbate
the situation. You’re right that in every society there are some people
who will rise above other people. That’s true in Sweden, and it was true
in Krugman’s 1960s. Krugman and I are not utopians who envisage a world
where all people and incomes are the same. We’re just saying that the
inequality in the US today has gone too far. Maybe a CEO really does deserve
to make 40 times more than an average worker – that is, make more in a
day than the worker does in a month. But now the ratio has gone into quadruple
figures, the CEO makes more in one day than the worker does in three or four
years. And I can see no justification for that. Therefore, don’t abolish
the estate tax, which does a lot of redistributive good at the expense of a
tiny proportion of the population. Don’t pass tax bills where 50% of the
benefit goes to 1% of the population. Do concentrate on improving the lot of
the poorest 10% of society before improving the lot of the richest 1%.
And don’t put words into my mouth: I’m not saying that the increase
in the wealth of the rich has come at the expense of a decrease in the wealth
of the poor. I’m just saying that the richer you are, the more likely
it is that you’re going to get much richer very quickly, and the poorer
you are, the more likely it is that you’re not going to any richer at
all. And maybe we should seek to find ways of redistributing that marginal future
excess wealth from the people who are already stinking rich to the people who
actually need it.
MATTHEW: I think this is the point where we stop. Boiled down to too many fundamental
differences. For example, “deserve” has nothing to do with it. There
aren’t many breakdowns in how the market allocates wages, except when
you start dicking around with it, such as minimum wages. And I don’t believe
there is anything such as excess wealth and am uncertain about the notion of
income redistribution for some undefined notion of fairness.
(At this point Matthew also pointed me to an old Wall Street Journal editorial,
which, he says, "shows how income mobility renders moot a lot of the arguments
about economic inequality.")
But of course I don’t want to leave Matthew with the last word. Who do you
think is right?