Robert H. Frank is Henrietta Johnson Louis Professor of Management and Professor of Economics in the Johnson Graduate School of Management at Cornell University. Frank is a monthly contributor to the “Economic View” column in The New York Times and a Distinguished Senior Fellow at Demos. He has also served as a Peace Corps volunteer in rural Nepal, chief economist for the Civil Aeronautics Board, fellow at the Center for Advanced Study in the Behavioral Sciences, and was Professor of American Civilization at l’Ecole des Hautes Etudes en Sciences Sociales in Paris. Frank’s books, which include Choosing the Right Pond, Passions within Reason, Microeconomics and Behavior, Luxury Fever, What Price the Moral High Ground?, The Winner-Take-All Society (with Philip Cook), Principles of Economics (with Ben Bernanke), and The Economic Naturalist, have been translated into 22 languages. His most recent book, The Darwin Economy: Liberty, Competition, and the Common Good, was published by Princeton University Press (September, 2011). Frank holds a BS in mathematics from the Georgia Institute of Technology, an MA in statistics from UC Berkeley, and a PhD in economics, also from UC Berkeley.
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Morris: Before discussing The Darwin Economy, a few general questions. First, who has had the greatest influence on your professional development?
Frank: My reigning intellectual heroes among living economists are Thomas Schelling and Ronald Coase. Schelling’s 1978 book, Micromotives and Macrobehavior, persuaded me that the link between rational individual behavior and collectively desirable outcomes is extremely tenuous. And it was Coase’s work that taught me how to think much more clearly about how best to resolve conflicts between individual and group interests.
Morris: In your opinion, what are the most common misconceptions about economics? Which of them seems to cause the most serious problems?
Frank: The most glaring deficiency in traditional economic models is that they completely ignore the role of context in evaluation. Questions like, “Is my suit OK?”, or “Is my job performance satisfactory?”, are impossible to think about in the absence of a suitable frame of reference. For an interview suit to serve its purpose, it must make you look good relative to other candidates for the job you want. For your job performance to be satisfactory, it must compare favorably with the performance of others who want the same promotion you do. As Charles Darwin saw clearly, much of life is graded on the curve, and conventional economic models completely ignore that fact.
Morris: Everyone else has an opinion about how best to create more jobs. What do you suggest?
Frank: We’re in a classic demand-shortfall recession. There aren’t enough jobs because total spending is too low. Consumers won’t lead the way because they’re busy paying down debt and are fearful they’ll lose their jobs, if they haven’t already. Businesses, which are currently sitting on mountains of cash, won’t spend either, because they already have sufficient capacity to produce more than people are willing to buy.
As John Maynard Keynes taught us in the 1930s, in such situations, government is the only entity with both the motive and the ability to boost total spending by enough to put people back to work. As it happens there are long lists of important public projects that cry out to be done. The American Society of Civil Engineers, for example, recently identified some $2.2 trillion in desperately overdue infrastructure maintenance. No one denies that these projects need to be done, or that postponing them will only make them more expensive.
Many of the people and machines required for these projects are currently idle. Materials prices and interest rates are at historical lows. We should be moving full speed ahead on this work. Yet we’re told that we cannot, that government cannot spend more than it takes in, any more than a family or business can.
That’s true as a statement about the long run, but it’s completely false for the short run. Getting the economy back on its feet is properly viewed as an investment in future prosperity. When businesses and consumers confront attractive investment opportunities, often the only way to seize them is by borrowing. The same is true for government. Contrary to the pronouncements of critics of economic stimulus, these investments will not impoverish our grandchildren. Continuing to allow the economy to languish in recession is the surest way to impoverish them.
Morris: Everyone also has opinions about the federal government. In terms of economics, in what specifically do you think only the federal government should be involved?
Frank: The states and local governments are not legally permitted to run deficits in times of recession, which is why they’ve been slashing employment and spending for the past several years. But that has only made the recession worse. Only the federal government has the power to spend beyond its current revenue. It shouldn’t do that when the economy is at full employment. But it’s an essential step for an economy mired in recession.
Morris: Here’s the inevitable follow-up question: In terms of economics, in what specifically do you think only the states should be involved?
Frank: As with the economic stimulus problem just discussed, unless a problem can only be solved (or only be solved well) at the national level, the states should be free to intervene as they see fit.
Morris: Since 1996—with one exception (2008)—fewer than half of those eligible to register to vote in fact registered; worse yet, fewer than half of those registered then voted. What do you make of that?
Frank: As economists have long noted, the puzzle is not that so few people vote, it’s that so many do. After all, no individual’s vote has ever tipped the balance in a presidential election.
Morris: Now please shift your attention to The Darwin Economy. When and why did you decide to write it?
Frank: I was driven by a growing sense of frustration about the national political conversation as the 2010 elections approached. The slogans and pronouncements coming from Tea Party spokespeople bore no resemblance to the choices actually before us.
Morris: Any head-snapping revelations while producing the manuscript?
Frank: When I sat down to write in May of 2010, my goal was to combine the essential assumptions that lie behind conservative political arguments with Darwin’s central observation that life is graded on the curve and see what kind of conclusions would result. I thought the additional assumption about the importance of context would invalidate many of the standard libertarian conclusions about how best to organize society. But I was surprised at how little of the traditional libertarian edifice survives once we take adequate account of the of context
Morris: To what does the title of Chapter 2, “Darwin’s Wedge,” refer?
Frank: I use that term to describe the conflict that often exists between individual and group interests. Adam Smith’s uncritically enthusiastic modern disciples portray his invisible hand theory as saying that market forces reliably harness selfish individuals to serve the common good. That’s often true, but as Darwin recognized clearly, many traits that serve the interests of individual animals make life more difficult for larger groups. The massive antlers of the bull elk are a vivid case in point. Spanning four feet and weighing more than 40 pounds, they greatly compromise the mobility of bulls when they try to escape from predators in densely wooded areas. But they are also the weapons upon which bulls rely in their battles with one another for access to females. A lone bull with small antlers would never transmit copies of his genes into the next generation. But if bulls could act collectively, they’d favor a resolution calling for each animal’s antlers to be scaled back by half. Fights would be resolved as before, since it’s relative antler size that matters, but each animal would be better able to escape from predators.
Morris: How do you also explain the enduring power of a meme, namely, “that government is the source of all ills”?
Frank: There have been hundreds of millions of dollars spent to propagate that meme in recent decades. And the success of those messaging investments has no doubt been enhanced by the fact that government actually is the source of many ills. But the private sector isn’t perfect either, and no society has ever succeeded without a decent government. Unless we can act collectively, there would be no way to defend ourselves, no way to define or enforce property rights. We couldn’t curb congestion or pollution or build and maintain public infrastructure. So if government is inevitable, the challenge is to come up with the most effective one possible.
Morris: For those unfamiliar with John Stuart Mill’s harm principle, what is it and what is its relevance to solving current economic problems?
Frank: Mill believed that the only acceptable reason for government to limit a person’s liberty was to prevent him from causing unacceptable harm to others. Mill was not a libertarian, but many libertarians are quick to cite this principle when arguing against a regulation that they oppose. And I believe most thoughtful libertarians are prepared to embrace something fairly close to Mill’s harm principle. But as I argue in the book, accepting that principle implies accepting many of the institutions of the modern welfare state that libertarians have vigorously opposed in the past, such as safety regulation.
We’ve long known that firms can pay higher wages if they spend less on workplace safety enhancement. Libertarians ask, “If a worker is willing to accept higher wages in return for his agreement to exercise greater caution while performing his job, why should the government prevent him from making that choice?” It’s a rhetorically powerful question, yet it overlooks the fact that the agreement in question will have adverse effects on others. One reason that might motivate a worker to accept a riskier job at higher pay, for example, would be that doing so would enable him to bid more effectively for a house in a better school district. But if other workers did likewise, none would achieve the goal they were striving for.
A good school is a relative concept, and the better schools are located in more expensive neighborhoods. But when everyone bids more for a house in a better school district, they succeed only in bidding up the prices of those houses. As before, 50 percent of all children will attend schools in the bottom half of the school quality distribution. As in the familiar stadium metaphor, all stand, hoping to get a better view, only to discover that no one sees better than if all had remained seated. Under the circumstances, it’s easy to see why well-informed workers would welcome limits on their ability to trade safety for higher pay
Morris: Please explain how and why “it’s often possible to mitigate harm to others without having to enact prohibitions at all.”
Frank: This is the principal lesson of early government attempts to curb environmental pollution. When I first moved to Upstate New York, we read articles every day about acid rain in the region, which was caused mainly by SO2 emissions from coal-fired electric plants in the Midwest that precipitated over New York State as sulfuric acid. The first attempts to curb SO2 emissions relied on intrusive, command-and-control regulations. Utilities were told where to buy their coal and what brands of scrubbers they had to install on their smokestacks.
But eventually the recommendations of economists prevailed, and the Clean Air Act Amendments of 1990 established a market for tradable SO2 permits. The reason companies were discharging so much SO2 in the first place was that it is costly to filter it out and they had been allowed to discharge it into the air for free. But if a company needs a valuable permit for every ton of SO2 it discharges into the air, it suddenly becomes incredibly creative at discovering cheaper ways to eliminate SO2. Other companies that lack cheap ways of filtering out SO2 are forced to buy the permits. This new approach enabled us to achieve the air quality targets much sooner than expected and for only about one-eighth the cost that had been projected under command-and-control regulation.
The same logic applies to other activities that cause harm to others or put them at risk. Consider someone who’s weighing whether to buy a 7500-pound SUV or a 3000-pound station wagon. If he has only a slight preference for the SUV, he’ll choose it, even though the much heavier vehicle would put all other motorists at greater risk of injury and death. If passenger vehicles were taxed by weight, however, he’d have an incentive to take the relevant risks into account when he made his decision.
Morris: It seems highly unlikely that governmental waste can be eliminated but can it at least be substantially reduced? If so, which specific steps must be taken immediately?
Frank: The primary source of waste in government is that legislators are often under heavy pressure to vote for projects that will benefit their campaign contributors, even when those projects fail a simple cost-benefit test. But with the Supreme Court showing little interest in permitting tighter rules on campaign contributions in recent years, there is little reason to be optimistic that we’ll start curbing this kind of waste any time soon.
Morris: What are “expenditure cascades” and why are they significant?
Frank: An expenditure cascade is the term I use to describe a basic change in spending patterns that has resulted from a change in the historical pattern of income growth. For the three decades after WWII, incomes grew at about 3 percent a year for people up and down the income ladder, but since then most income growth has occurred among the top quintile. And among that group, most of the income growth has occurred among the top 5 percent. The pattern repeats itself all the way up. Most of the growth among the top 5 percent has been among the top 1 percent, and most of the growth among that group has been among the top one-tenth of one percent.
Many decry rising inequality because it makes those who’ve fallen behind feel impoverished. But it’s done much more than cause hurt feelings. It has also raised the real cost to middle-income families of achieving many basic goals. The process begins with the completely unremarkable fact that top earners have been spending at a substantially higher rate than before. They’ve been building bigger mansions, staging more elaborate weddings and coming-of-age parties for their kids, buying more and better of everything.
Many social critics wag their fingers at what they perceive to be frivolous luxury spending. But that misses the point that consumption norms are local. It’s not just the rich who spend more when they get more money. Everyone else does, too. The mansions of the rich may seem over the top to people in the middle, but the same could be said of middle-class houses as seen by most of the planet’s seven billion people.
The important practical point is that when the rich build bigger, they shift the frame of reference that shapes the demands of the near rich, who travel in the same social circles. Perhaps it’s now the custom in those circles to host your daughter’s wedding reception at home rather than in a hotel or country club. So the near rich feel they too need a house with a ballroom. And when they build bigger, they shift the frame of reference for the group just below them, and so on, all the way down.
There’s no other way to explain why the median new house built in the U.S. in 2007 had more than 2300 square feet, almost 50 percent more than its counterpart in 1980. Certainly, it’s not because the median earners are awash in cash. (The median real wage for American men was actually lower in 2007 than in 1980.) Nor is there any other way to explain why the inflation-adjusted average cost of an American wedding had grown almost threefold during the same period.
Morris: Please explain why there is far more waste created in the private sector than in the public sector.
Frank: The private sector is first of all much larger than the public sector. The waste we see in that sector does not result from the fact that people spend their money carelessly. Mostly, it occurs because what one family must spend to achieve its goals often depends heavily on what other families spend.
As noted, for example, all parents want to send their children to the best possible schools. But because a good school is a relative concept, a family cannot achieve its goal unless it outbids similar families for a house in a neighborhood served by such a school. Failure to do so often means having to send your kids to a school with metal detectors at the front entrance and students who score in the 20th percentile in reading and math. Most families will do everything possible to avoid having to send their kids to a school like that. But because of the logic of musical chairs, they’re inevitably frustrated.
Parents confront similar dilemmas when deciding how much to spend on a child’s coming-of-age party or wedding. The expenditure cascades spawned by higher spending at the top in those categories have raised expectations about how one should mark important social milestones. Of course, a family always has the option to spend considerably less on such events than most of its peers do. But it can do so only by disappointing loved ones, or by courting the impression that it failed to appreciate the importance of the occasion they were celebrating.
It is no exaggeration to say, then, that rising inequality has driven many of the 99 percent into a financial ditch. It also helped spawn the housing bubble that gave us the financial crisis of 2008, the lingering effects of which have forced many OWS protesters to try to launch their careers in by far the most inhospitable labor market we’ve seen since the Great Depression. Even those recent graduates who manage to find jobs will suffer a lifelong penalty in reduced wages.
Meanwhile, rising inequality hasn’t really accomplished anything of value for its ostensible beneficiaries, the top one percent. They’ve all built bigger mansions and staged more lavish parties. But in so doing, they’ve simply raised the bar that defines what’s considered adequate in these categories.
Morris: Here’s a follow-up question: What valuable lessons about economic reform can be learned from that reality?
Frank: The fact that many private expenditures are mutually offsetting actually happens to constitute a remarkably good bit of fiscal news. Mutually offsetting spending patterns are wasteful in the same way that military arms races are. In such situations, if each party spends less, nothing is sacrificed, yet resources are freed up that can be put to much better uses. We could curtail private spending by several trillion dollars a year without requiring painful sacrifices from anyone. That would be more than enough to rebuild our crumbling infrastructure and eliminate government indebtedness once and for all.
Morris: And how would you propose to do that?
Frank: My central policy proposal in The Darwin Economy is to scrap the current income tax in favor of a much more steeply progressive tax on each household’s consumption expenditure. Families would report their taxable income to the IRS (ideally under a tax code that greatly simplifies the calculation of taxable income), and also their annual savings, as many now do for IRAs and other tax-exempt retirement accounts. The difference between those two numbers—income minus savings—is the family’s annual consumption expenditure. That amount less a large standard deduction—say, $30,000 for a family of four—is the family’s taxable consumption. Rates would start low and would then rise much more steeply than those under the current income tax.
Families in the bottom half of the spending distribution would pay lower or no higher taxes than under the current system. But high marginal rates on top spenders would not only generate more revenue than the current system, but would also reshape spending patterns in ways that would benefit people up and down the income ladder.
If top marginal income tax rates are set too high, they discourage productive economic activity. In the limit, a top marginal income tax rate of 100 percent would mean that taxpayers would gain nothing from working harder or investing more. In contrast, a higher top marginal rate on consumption would actually encourage savings and investment. A top marginal consumption tax rate of 100 percent would simply mean that if a wealthy family spent an extra dollar, it would also owe an additional dollar of tax.
That feature of the tax gives rise to what it would be no exaggeration to describe as fiscal alchemy. Consider, for example, how the tax would affect a wealthy family that had been planning a $2 million dollar addition to its mansion. If it faced a marginal consumption tax rate of 100 percent, that addition would now cost $4 million—$2 million for the job itself, and another $2 million for the tax on it. Even the wealthy respond to price incentives. (That’s why they live in smaller houses in New York than in Seattle.) So the tax would be a powerful incentive for this family to scale back its plans. It could build an addition half as big, for example, without spending more than it originally planned.
The fiscal magic occurs because other wealthy families who’d also planned additions to their mansions would respond in a similar way. No one denies that, beyond some point, it’s relative, not absolute, mansion size that really matters. So the smaller additions would serve just as well as if all had built larger ones.
The tax would have similar effects in other luxury domains. The amounts spent on multimillion-dollar coming-of-age parties would grow less quickly, as would the amounts spent on weddings, yachts, jewelry, and other items. And these changes would attenuate the expenditure cascades that have squeezed middle-class families.
Morris: You suggest that “efficiency rules.” Please explain.
Frank: One of the deep lessons of Ronald Coase’s work is that when people bump up against one another in the course of pursuing their goals, it is in everyone’s interest to resolve any resulting problems in the least costly ways possible. As I tell my students repeatedly, when the economic pie grows larger, it’s always possible for everyone to have a larger slice than before. So it’s really in all of our interest to make the economic pie larger by eliminating waste whenever and wherever possible.
No one could argue with a straight face that the couples getting married today are much happier just because their wedding celebrations cost three times as much as those in 1980. Bigger mansions and costlier parties are wasteful in the same sense that larger antlers on all bull elk are wasteful. The good news is that simple changes in the tax system can eliminate much of this waste without having to deny people the right to decide for themselves how best to spend their money.
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