The Great Stagnation | Matthew Yglesias & Tyler Cowen

Hi, Tyler.

Hello, Matt. How are you?

I'm good. I'm good. I'm Matthew Iglesias. I'm a fellow and blogger at the Center for American Progress.

And I'm Tyler Cowen. I'm a professor of economics at George Mason University, and I blog at Marginal Revolution.

And you're also author of a new book, right?

That's right. It's called The Great Stagnation, and it's an ebook only. It came out about 2 weeks ago. And it's about American macroeconomics and why we're not as rich as we used to think.

Why we're— and it's about— but not— it's not about us being poorer than we used to be.

We are getting richer at a slower rate. Since 1973, the growth rate for median income in the United States has slowed dramatically. And from, say, 1973 to 2004, It's only gone up about 20 to 30%. But this also corresponds to an anecdotal observation, namely that my grandmother in her lifetime saw a lot of big changes. And other than the internet, I haven't seen many big changes in my lifetime. So she got the flush toilet, electricity, automobiles, many other things. So progress is slowed, but economists often have not quite been willing to admit this.

I mean, I think in particular, you know, a lot of the arguments in the book are very novel, but the basic subject of the stagnation is something that's I think pretty familiar to liberals. There's been a lot of discussion of, you know, median wage stagnation in progressive circles, but more sort of right-of-center thinkers I think have been sort of skeptical of even just that premise that there's anything that needs to be explained.

Sure, there's a tendency to deny it. There's a very odd ideological split on this issue. If you go back and look at David Ricardo— you're reading Ricardo right now, I know— Ricardo was a classical liberal, very free market, and he thought that during his time there was a certain amount of stagnation. One of the other people promoting a stagnation thesis is Peter Thiel, who's a very radical libertarian. But what I find odd is that in the longer term, government has grown quite a bit. So to the extent you think that big government damages economic growth, you would think people would be, on the right, somewhat sympathetic to his stagnation thesis. But there's somehow a juggling they want to do. They want on one hand to say, "Markets are really dynamic and innovative and great, and we can't do anything to disturb them." But then looking backwards, there's also a certain amount of complaining— and pushing all of that into one doctrine is a little complicated. So my way of resolving this, I think, is to realize there has been a significant decline in the rate of improvement. It probably won't last forever. But the progressives like Krugman and Jacob Hacker, they want to say that's because of politics and redistribution. But I think fundamentally at the core of this is science and technology.

But I mean, you know, I mean the reason I think we have the sort of political mapping of this is that there's a, I mean the perception I think on both sides is that since the election of Ronald Reagan has been a sort of, you know, period of conservative political hegemony in the United States, particularly on economic policy issues. It's obviously on, you know, gay rights and topics like that we've moved to the left. So I mean I think that's why you have an impulse toward the left being skeptical that well-being is increasing and on the right the habit is to sort of cheerlead for recent trends.

Sure, but since the time of Reagan, it's hardly an unambiguous victory for libertarian ideas or policy doctrine. There's a fair amount of deregulation, but there's also a big increase in regulation. And in terms of transfer spending, we see the Republicans and especially Bush I doing a big boost in that spending. So it's hardly that we've had an unambiguous move toward greater liberty in a conservative or libertarian sense of that term.

No, I mean, I agree, but I mean, I think that that's part of the sort of the larger perceptual grab. I mean, you don't dwell a great deal in the book on why is it that things are seen this way, but I mean, Part of what I think you're trying to say is that the past 30 years of Republicans winning a lot of elections and passing several tax cut bills haven't actually generated some kind of, you know, small government revolution.

Sure, and those tax cuts, like Brad DeLong, I call them tax shifts. They're not really tax cuts at all. I think there are two other factors here. For people overestimating the rate of recent technological progress. The first is the so-called chattering classes, which I suppose we belong to by definition.

Right.

They tend to live in New York or Washington, and those two cities really have gotten a lot better in the last 20 to 30 years, noticeably so. The other is smart people, media people, communicators, intellectuals, tend to be very heavily into the internet. And people who value the internet very highly, they haven't seen a great stagnation at all. I don't think that I personally have. I've used the phrase "infivore" to describe myself. And people who communicate tend to be infivores. So they see that things for them are fantastically better, but then again, we need to go back to this distinction of the intellectuals and the median American, and it's not quite the same path.

So I mean, you think basically that the people, you know, inclined to write and talk a lot about public events.— just disproportionately drawn. I mean, while we're here doing some, you know, unimaginable video chat recording thing, we know each other from blogs, things like that. I mean, we're the kind of people who have seen huge increases in well-being recently.

That's right. And if it's really important to you to have the music of Zimbabwe at your fingertips through internet radio and downloads, again, you'll feel you're much better off in the last 10 years, you are much better off. But the median American, a lot of it is about education and healthcare and also real estate. Where can you afford to live? And in those areas, we've seen a lot of price hikes, even with the bursting of the real estate bubble. It's not obvious what all of the improvements in quality are. And cultural consumption, it counts, but it's sort of a few percent of what those people spend their money on. For myself, it's a small percent because so much of it is free. And again, you're back to some really big parts of the budget. We've seen a slowdown in progress. Education, particularly graduation rates, are down, and they've been down since the '80s.

Well, you know, this is where I have some of the biggest questions about your argument, because I mean, on the one hand, you know, you point to a lot of evidence that the that the education system is not improving, that the formal K-12 schools are sort of stagnating. At the same time, the most dramatic progress has been actually in the information dissemination sphere, right?

Sure.

On the internet, in terms of books, culture, things like that. So I mean, why— if what we care about is people's actual knowledge and learning, I mean, why doesn't the enormous expansion of the sort of information economy outside of the schools offset, you know, any sort of like alleged problems in the classroom?

I think there's a few things going on here. One is simply that I think we've had more of a stagnation in incomes than in fun. Fun has progressed more rapidly than stagnation, which is good news. We shouldn't be pessimistic about that. But there are still a lot of aspects of human life where real incomes count.. And people have debts and governments have to run fiscal policies. And what you would call gross jobs and revenue, they're not irrelevant. Even in a world where people are having more fun, the numbers still have to add up. And we haven't managed to make that happen at either government or household levels. But the other, again, is going back to this distinction between the median and intellectuals. What the median American does with the internet, I think, is not an enormous amount of education. And if you've come out of a bad high school and you're not incredibly literate, you may watch music on YouTube and you may use Facebook and you may send emails, but how much, say, reading smart blogs will improve your understanding of politics, I think the internet and in-your-face education are complements very often and not substitutes.

So, I mean, in a sense you might say that— well, I mean, I guess common sense is you You're not going to learn to read on the internet, and if you're not taught to read properly, then you can't take advantage.

I think some people actually do.

So much of the text, let's say.

But again, going to the median, that's not a typical outcome. I think you actually do have people who literally almost trained themselves to become scientists using the internet in fields where they don't have formal training, and that's great. But if you look at a household earning $50,000 a year, with a married couple and 2 kids and mortgage payments and worried about education, it's really important that they send their kids to good high schools and then to a good college, and those prices are up. And whether the productivity of education is rising to a proportionate degree, at least test scores indicate that it's not. Test scores are not everything, but I find it worrisome we keep on spending more and test scores don't rise.

But, you know, in terms of the test scores and schools, I mean, there's sort of well-known demographic effects in education. And one thing you hear from a lot of people is simply that the demographics of the student population in the United States have gotten more challenging. And that's why, you know, if you look at subgroups, test scores for white children are up, test scores for black children are up, and test scores for Hispanic children are up, but the mix of those three has shifted and the median is flat. But that looks to me like a school system that's actually getting better under— but also dealing with a large number of immigrants, basically.

It may be getting better, but again, I think it's happening at a slower rate. So take, say, white children. If you're in the year 1900, the marginal white child who starts going to high school and college is very easily educable, has a very high IQ, is probably quite ambitious. And simply, the more people you educate, the harder it becomes to add value through a system of education. So it would be wrong to conclude education isn't better in any way whatsoever. But if you think of the main hypothesis as about a slowing of the rate of growth and a restricting of additional opportunity, we've plucked what I call the low-hanging fruit, and the problems we're left with to solve are just harder and it costs more money. And that again means they slow down. In growth and innovation. So I think that's consistent with the notion of a stagnation in relative terms.

So, I mean, explain what you mean by low-hanging fruit to a greater extent. I mean, in schools, what you're saying is that when you go from like only like 1% of people go to college to 2% of people, that it's easier to get gains there than than from the point where we're at now.

Sure, like take what is one of our favorite philosophers, Willard Quine. Did Willard Quine's grandfather go to college? Highly unlikely. So at some point in the American distribution, the marginal college student was a lot of people like Willard Quine. Right now, the marginal college student— I'm very familiar with the marginal undergraduate at George Mason, and that is far from the bottom of the distribution. But they're people who are really not well equipped to handle higher education. There was this recent study of Rochester that concluded only about 5% of the graduating high school seniors were ready either to work or go to college. So the low-hanging fruit is things you can do quite easily and get a high return readily. So the spreading of a lot of major innovations dating back from the Industrial Revolution— again, flush toilets, electricity, radio, cars— that drove a lot of very rapid progress in the early part of the 20th century.. But now we have cars and we're not about to have flying cars. Cars get better. They have side airbags, the music systems are better. But it's marginal improvement. It's like Ricardo's diminishing marginal returns. And that to me is a very useful framework for thinking about our current economy. And it's something in a way both sides wish weren't true. Republicans want to promise more tax cuts. Progressives want to promise more redistribution. We're going to get some degree of both, but as long as the rate of growth of typical income is slow, that's something that no policy really will overcome. Progress also will be slower.

But, I mean, the overall GDP growth rate isn't actually that much slower. I mean, this is why progressives have, you know, the redistributionist sort of paradigm that we do, that during this same time there's been— you know, a moderate slowdown in the overall rate of economic growth. But the slowdown at the median has been much, much more dramatic because we've seen a huge explosion in the earnings of very rich people.

Sure, I think we've had a lot of innovations. Some of them are financial innovations, which are not always very helpful for making the world better off. But in terms of broad-based innovations comparable to the first half of the 20th century, Again, other than the area of the internet, we haven't had many since 1973. And I'm attributing that slowdown at the median— a lot of it is due to science and technology. Whereas Paul Krugman or Jacob Hacker are more likely to think that somehow wealthy people haven't taken over government and done things through the state to redistribute income. But I think fundamentally it's a problem about the real economy.. And it's possible to remedy over time, but it's very hard to remedy in the short run. Keep in mind also, if you look at total factor productivity—

Right.

—that's a measure of how much of the increase in living standards is coming from new ideas. And that is very sharply down since 1973. It's almost zero. So we're getting richer by throwing more capital and labor at a lot of problems, but that's not the same thing as innovating more.

Right. So this is the point that household income has tended to go up more rapidly than actual wages have, right? I mean, there's more women in the workforce, things like that.

Sure. But, again, also more women in the workforce is a double-edged sword. It's great that there is more opportunities for women to work. It's given us a lot of one-time boosts in income. Where there's also been a cutback in household production that we're not measuring. And that as well makes the post-'73 period look not quite as progress-oriented as the numbers indicate. I think—

We've had a shift of activity from sort of unmeasured household work into out of the house, and so that winds up overstating the increase in how much is actually getting done.

And that's been a big shift. Also, the civil rights movement, which we would all agree is a wonderful development, it's led to a one-time shift due to different classes of people facing less discrimination. But looking forward, we won't capture comparable gains again. There's still some discrimination left to eliminate, but I don't think it will be as big as what we did the first time around.

Right. There's not another wave of formal segregation, undo. That's right. Well, that's a kind of gloomy view of the future, it seems to me, because I mean you're suggesting that a lot of these problems, I mean particularly problems with education, I mean even if tomorrow schools would become dramatically better, it would take decades for better outcomes to come from that.

Absolutely. If you think of, you know, being a 30-year-old as a very productive, innovating person, if school started to be better now, by the time that is fed into 30-year-olds, takes a long time. And then it takes time to implement those innovations. I don't think of myself as pessimistic. I guess you could say I'm pessimistic compared to people who deny there's a problem. But I think my view of the problem, once we realize it's a problem, is a relatively optimistic view. That is, I think we will get out of it. That science moves in spurts. If you look at previous American history or even the previous history of the world, you have, say, you know, the invention of writing, the invention of fire, the Industrial Revolution. After that, you have huge spurts of progress. You then have consolidation with much slower growth. And then eventually you get another huge spurt. So I think the time between spurts has speeded up. And the Internet, I'm predicting, will likely prove to play a big role there. Science communicates much more efficiently. I don't think those gains have kicked in yet, but if we had our next big spurt 30 years from now rather than 200 years from now, that's actually what I expect.

So this is what, to me, is the sort of the least persuasive part of the argument, is the connection between these sort of phenomena you're pointing to and the the allegation that science has slowed down. I mean, for one thing, it's a little bit difficult for me to see why would science have slowed down during this period when basic communication between scientists has gotten so much easier, when the world, the population of educated people in the world is larger than it's ever been. You know, I mean, it's, you have this sort of this one chart— that shows a slowing rate of science. But I don't really know how you would even measure something like that.

Well, if you take some simple measures— some of these are in the book— but look at patents per scientist or patents per capita or the return on science relative to what we spend on R&D, all of those have been falling for some number of decades. So science hasn't slowed down in the following sense. We are discovering more and more things than ever before. We know much more. That's wonderful. But the ability of science to create practical things that make everyone better off is temporarily at a much slower pace than it has been in times past. And I think total factor productivity, median income, data on patents, and data on the productivity of R&D, or anecdotal micro case studies of, say, pharmaceutical drugs,. They're all pointing us in the same direction of this slowdown. And the more I looked at the different kinds of data coming from different sources measured mostly in different ways, that was really what convinced me.

But I mean, how much of Total Factor Productivity is really driven by ideas of a scientific kind of nature versus— I don't know. I mean, I think of more sort of organizational and, and for lack of a better word, like business strategy-ish ideas as what really drives that forward?

Well, we don't know. If you look at a period like the late 1990s, that's the one time since 1973 when ideas-based progress seems to be really quite strong. And I think it is. So you could say my thesis is not the Great Stagnation, it's the Great Stagnation except for a bunch of years in the '90s.— that is maybe a more accurate description. And Paul Krugman and others have suggested this is probably because of Walmart and retailing innovations. And I think that's true. But to some extent, even those are throwing labor and capital at a problem. And we just don't, in any of the numbers since '73, see anything comparable to those years in the '90s. But I do think we did have this period recently when we weren't growing at this slower pace in terms of ideas.

Right. This is the idea that sort of big box retailing brought a kind of an increase in productivity and maybe just-in-time shipping and things of that kind of nature. Now, you mentioned a little bit earlier real estate, you know, and the sort of increasing difficulty that people may have in affording it. And I recently finished Ed Glazer's book, which I think you mentioned earlier today on your blog. That's right. And sort of gets at some of this because it struck me that this identifies a kind of a low-hanging fruit that, I mean, as you said, the quality of life in some specific places in the United States, New York City being one of them, Washington, D.C. being another, really has increased a lot in the past 20 years thanks to crime, basically, but the main way that that's manifested itself has been in just these places becoming more expensive, but in principle you could have a different regulatory environment in which when a place became a better place to live, more people moved there because you built taller buildings, Sure, you know, you've written a lot on this and I agree completely.

I think there are two issues where right now we could have some very low-hanging fruit virtually for nothing. One of them is to allow greater densification of cities, which would cause a lot of people to earn more and be more productive and trade more ideas with others. It would also boost their consumption opportunities, but you need to allow much denser construction. But it could be done not only for free but at a net social profit. Though not everyone would be happy. And the other is a lot more high-skilled immigration, which would also be a win-win. It would be great for us fiscally. It would help rescue our problems with entitlement spending. And I think we both advocated those two things. So two things we could do right now, not 30 years from now, but in the next few years, would have fairly significant payoffs. We're simply not willing to do, and I don't really see them coming up on the agenda.

No, I mean, neither do I, but I mean, I guess this was sort of part of my question about, you know, what is the meaning of low-hanging fruit? You know, because on the one hand, you know, free farmland in the western United States, you know, was a great sort of example of low-hanging fruit. You know, and people could come here from Europe and, you know, start farms and, you know, there was a lot of living standards associated with that. On the other hand,— you know, as a political endeavor, you know, armies had to be raised, a lot of Indians had to be, you know, shot, things like that. So, you know, I mean, it seems to me that there might be some things, you know, we could do quite in the short term, but they're not low-hanging fruit politically.

That's right. But there are definitely a number of things we could do in the short run that would significantly boost our chances of having a higher economic growth rate. I think there's a lot of areas with regulation. A lot of areas are overregulated. Wind power is something. We have the technology. You can't do it everywhere. We could do a lot more of it. It would be environmentally friendly. We're just not willing to do very much of it. Some people say nuclear. I know less about that. It also seems more expensive to me, but maybe possibly that's a candidate.

Mm-hmm. Mm-hmm. And, you know, but so this, I think, gets back closer to a version of the Krugman-Hacker thesis that, in fact, we are looking at a kind of political dysfunction.

I think it's a different political dysfunction than theirs, though. Krugman and Hacker don't say exactly the same thing, but they place a lot of stress on wanting more unionization.— and wanting what you broadly call more progressive policies. Now you could say greater densification is progressive, but it's not a directly distributional issue. It seems to me that people in both parties don't really want greater densification. It's a question of people having locked-in interests. And no one other than people like us are pushing for it that I can see.

No, no, I mean it's a sort of a crank issue at the moment. But I mean, when I read Hacker and Pierson in particular, I mean, they're political scientists, and so what I'm struck by is that they get, they have a big argument about sort of trends in economic outcomes and then an argument about the political foundations of these trends and then a kind of hand-wavy about what exactly it is that they think has been done in the political process. The implication, you know, if you read them and if you know them and if you talk to them, is that sort of the advancing the policy agenda of the labor wing of the Democratic Party is the solution to these problems. But I more and more think that they're, that they're right about a lot, but that they're possibly missing the economic foundations, and then if you look at things around intellectual property policy and things around land use regulation, that there you have sort of, I mean, political governmental interventions that you can, you know, would tend to increase the economic well-being of certain kinds of entrenched incumbents, even though these are not at all the issues that the Democratic Party coalition is prepared, you know, is organized to address. That's right.

I think also with the Hacker book in particular, it doesn't explain very well why Western Europe has seen a growth slowdown since the 1970s. One thing I find persuasive about the Great Stagnation Hypothesis is that all the nations on the frontier— at about the same time seem to have falling total factor productivity and somewhat falling rates of growth. Now technology is broadly common across U.S., Western Europe, Japan, and a few other countries. So to me it doesn't prove it's all about technology and science, but that it's some kind of public good. Whereas if you think it's politics, it's harder to understand why, say, Japan has also seen —actually a more extreme stagnation than the United States has. And while some of that is their bad monetary policy, it simply can't be the case that that's the main or the only thing going on.

Right. So you see that we're having a lot of growth in poor countries, which is the sort of catch-up that was anticipated by— Phenomenal catch-up. —economic theory a long time ago. That's right.

And finally it's arrived. And it seems to be more robust than I had thought even 2 or 3 years ago. Places like Turkey and Brazil politically have made very rapid progress toward this being sustainable in my view. And maybe, maybe in the Middle East. I don't know. I don't understand what's going on there. But certainly 2 months ago, I didn't expect to see any chance of progress. And now at least there's something going on.

And that's because, I mean, in principle, Egypt, should be able to look at the way things are done in a somewhat richer country and just kind of copy the business practices that already exist. And that if there's political barriers standing in people's way, that's fine, but basically what you've done in China is just taken technology that exists elsewhere and built factories that employ it. Absolutely.

Let me just interrupt. My light turned off because I had my door closed for too long. This is one of these modern innovations that isn't worth very much. So I need to get up for about 5 seconds and turn the light back on. Excuse me. Why don't you say something more about China?

Sure. I don't even know what to say about China.

Okay. That did it somehow. I think what we're seeing in the world is catch-up growth is robust, but the countries at the frontier are growing more slowly. So culturally and politically, that's a relative shift of power. But when you look at commodity prices, it means the countries that aren't growing at all, and you've blogged this point in one regard, they really have it much tougher. And the countries at the frontier, they also face higher commodity prices. And that too is a drag on growth and it's a drag on macroeconomics because when you have price inflation not through monetary policy but through a higher price of wheat and oil, it looks to people like price inflation and people worry about it., and it's harder to get a pro-growth macro policy. It's not the main point of my argument, but it's another problem we're having. That catch-up growth in some ways is not as good for the leaders as I would have thought 10 years ago. We're in this funny intermediate stage where the countries playing catch-up aren't yet bringing new ideas to the table, but they're bidding for the same resources.

Right. I mean, we've gotten used to this idea. Since the '70s at least to a very optimistic view about economic growth and commodities where we grow by learning, so as demand grows for metal or oil or whatever, we get smarter about ways of extracting it and yada yada. But if what we're seeing mostly is catch-up, then we're not necessarily seeing any —actual innovations in the question of how do we get these commodities.

That's right. And this long-term trend chronicled by Julian Simon of falling real resource prices, that to me is saying that during those periods we're not having a lot of catch-up growth. That's associated with optimism, but arguably it's a very pessimistic outcome. It means just one small set of countries is getting richer, and maybe overall you should be happier when those prices are going up very rapidly. Because the catch-up growth for global welfare is more important than the people at the frontier getting an extra percent of growth. But it's a problem for Americans. Absolutely. And again, I think it's a problem that within 30 years' time or less will be solved. But I think China is not so far from being on the frontier in certain areas, like say solar power. But it's not the case yet. Brazil in some areas seems to be approaching the frontier. Some of the biofuels from Brazil seem better than what the United States produces. That's again a political reason why we don't capture that low-hanging fruit. But the fact that they could do it at all, do something better than what we or anyone else did, is striking. And that will come online in a major way, I think, over the next few decades.

It's just —Well, if you have a larger set of countries at the frontier, presumably each country will have certain politically dysfunctional elements to it, but they won't all have the same ones. —That's right. —Right, which may allow, as you're saying, that, you know, we, I mean, the U.S. and Brazil both have kind of agricultural politics around our biofuels policies, but they're different politics.— and the Brazilian politics seems to be hitting on a better solution.

They're pro-sugar and we're pro-corn, and it so turns out you're better off being pro-sugar. Keep in mind, the number of young people in frontier countries, it's basically going down. Right. Western Europe most of all, and Japan. Less so the United States. But we're really counting on some of these other countries doing something good on the frontier fairly soon. Because as we age as a society, per person, we're becoming less innovative, I would suspect. There is some peak age for innovation, and it's often fairly young depending on the field.

But here, I mean, the problem is that China is not— is younger than the United States, but actually, I believe, aging at a more rapid rate.

That's right, and their pyramid, so to speak, will be skewed by the one-child policy. Which in my opinion will not work out very well for them.

Right. So I mean, you know, we have this catch-up growth which is hopeful, and we also have a sort of growing demographic period in developing countries, but it's often in different countries. I think that the— there's huge numbers of young people in the Middle East, but that's where— I mean, well, no one knows what's —what's going to happen in Egypt, but sort of political and economic progress seems slowest there. That's right.

I think there's a lot of room for someone to write a good book on what catch-up growth really means. People usually use the Ricardian model of comparative advantage, which in my opinion is still a completely correct model. Other countries grow, you trade with them more, you're both better off. It's all true. But those are not always the main or first-order effects. There's a lot of other effects. Which we're starting to learn because they make the headlines, but we really hadn't thought through very well, in my opinion, not from any side of the political spectrum.

Right. Well, I mean, we've gotten— it's funny because this sort of model of catch-up growth has been out there, you know, forever, but it hasn't actually happened, or not very much of it has happened throughout the sort of observed history of the industrial West. Sure.

In a way, the first case of catch-up growth could be the West catching up to China and the Islamic world. And that does not in every way work out well for them. Maybe in the long, long run it has, but for many centuries— how was the 18th century in the Islamic world, the Middle East, Afghanistan? Not very pretty.

Right. So in a sense, maybe the president is is right to exhort us, that we need to try to win the future.

Now Matt, you mentioned, I don't know if it was Ricard on Twitter or on your blog, but you're reading David Ricardo right now.

Right, I was.

I'd like to ask you, A, why you're reading him, and B, what you're getting out of it, and also if it relates to any of what we're talking about.

Well, yeah, I mean, I was trying to go back to really, really old-fashioned discussions of rent, you know, to the like non-metaphorical concept of economic rents because, you know, he's of course writing about an economy that's still very primarily agricultural, so the question of who has the good farmland is, you know, looms large in that time in a way that it hasn't recently. And my thought that I'm toying with is that in an economy that's more dominated by people working in personal services that in a sense this kind of geographical location is becoming economically important again in a way that hasn't been true in the industrial era.

Sometimes I've wondered if you can't think of Ricardo's model as to some extent applying today, that the rent is reaped by ideas. So there's plenty of labor and capital coming online, but ideas that a lot of people benefit from are somewhat scarce. —so the rents accrue there— Right.

—rather than demand.

Wait, sorry, what? So, you know, it may be that ideas are reaping the rents. Right. If there is an innovation slowdown, a lower rate of growth, you would expect the returns to ideas production per idea to be going up, even if the total returns are not going up. And that's going to mean higher rents per idea, which to some extent we see with IP.

Right, although I mean I think when we look at the distributional analysis of who's getting, I mean I think people would in some ways feel better about inequality at the top end if it was all sort of Bill Gateses and Mark Zuckerbergs, but it's the persistence of so many hedge fund managers and things like that in there among other things, that kind of drives some suspicion.

Some of this may be a funny kind of negative innovation. Let's say in 1963, people in finance were not very good at playing heads I win, tails you lose, even though some of those incentives were there on paper. But since, whenever you care to start it, in the last 10 years, Finance has become very good at playing heads I win, tails you lose. And they do so to a much greater degree. And some of that is regulatory, that more leverage is allowed. But I think it's also just people are more clever in finance and they have a lot more technical tools. And there are a lot of ways you can use the concept of an option to set up synthetic positions that maybe look safe on the balance sheet or trick a regulator or fool your shareholders, but are highly levered ways of playing this game. And that's the case where I think something like the progressive story is pretty clearly true. It's an actual transfer in the longer run from poorer people to wealthier people, and it's because we've had this bad innovation.

Right. I mean, I do think that a kind of, you might call it a cynical capitalism, sort of doesn't get quite as much attention. That it could be that there are sort of problems in the system., and with each cycle, you know, of heads I win, tails you lose, I mean, in just a classic competitive dynamic, the people and firms who are worse at it, you know, lose out, right? I mean, we just saw, right, for whatever reason, you know, Bear Stearns goes down, Lehman Brothers goes down, but other companies, you know, don't, and they win out, and so, you know, Is what you're getting, you know, people who are better and better at some socially useful financial allocation function, or are you getting financiers who are better and better at kind of playing heads I win, tails you lose? Sure.

No, I would agree we should have the financial sector shrink in this regard considerably. I'm not sure how much that will boost the rate of growth. The sad thing is it may just, if we succeed in doing it, prevent us from falling in future growth further, which is a scary thought. So I don't know how much gain is in there. We may just be looking to check the forthcoming losses.

Well, I think, you know, I mean, I think if you look at the current recession, right, I mean, at least I think you see that you might have a better functioning finance system. You might have some less severe downturns in the business cycle. I mean, it turns out to be quite difficult, I think, as a political and policy matter to really ameliorate these steep slumps.

Sure. I think now there are still people playing heads I win, tails you lose, but if you're in recovery mode, on average there are enough gains in capital values in the system that nothing explodes. Maybe some people manage to take advantage of the incentives, but at a social level, nothing noticeably terrible happens. And that's where I think we're at now. But since it's now become so clear how many bailouts are embedded in U.S. politics, I fear for the next time there's some sort of major crash, how much risk-taking will have been caught behind where we end up.

Yeah, well, and I find it disturbing that, I mean, something you could say 10, 15 years ago is that I think a lot of people genuinely thought that these financial problems that were coming around the corner didn't exist. You know, I mean, it was a, I mean, I'm sure there were, you know, cynics and crooks and so on and so forth, but to a large extent there was a sense sincere kind of mistake. Sure, I thought that. Right, and I don't know barely anybody today who really thinks that what's been done has solved the problem. That's right. I mean, there's some people who I will hear claim made it worse, and there's people who claim that it's been made better, but I don't think anyone thinks that it's been solved. That's right. And yet there's no momentum to doing anything more about it.

I think the tough thing is, you know, say you're President Obama or for that matter a Republican leader, to somehow get on TV in whatever form and say, "We're moving from 30:1 leverage or 34:1 to 12:1 and this will mean mortgages and consumer credit cost more and we're going to do this because X number of years down the road if we don't there will be trouble." It's simply not— a winning strategy for anyone politically. So you may try various backdoor ways of getting there, which maybe even you yourself feel half-heartedly about. Because in a way, it only works if it hurts in the short run. If no one is suffering, you're not getting anywhere. And how much does anyone in office want to do that? I think not very much. Right.

But so, I mean, how is it that in the— I mean, —how is it that in the past, I mean, we used to have some very draconian regulations on the financial services industry, I mean, things that, you know, I mean, I would say, I think most people think, you know, went way too far, but presumably, I mean, it was the same deal back then that, you know, politicians liked it for people to be able to get loans and so forth. I mean, these sort of political economy problems can't be totally unsolvable.

I think there's a status quo bias. So if we started with different levels of credit availability, to keep them is not very hard. But when people have received more and then they have to cut back, I think that's significantly harder. And status quo bias, I think, as a concept is not as strong in public choice theory as it should be. So there's a lot of ratchet effects, and we're living through those now. And they're very difficult to overcome. I think the left in particular has faced this problem with Obama, and very often they end up blaming Obama. Right. But I blame— whether I agree with the ends they're seeking or not, I blame the ratchet effects. It's very hard to take things away from people. It's the same problem with densification of cities. You're telling some group of homeowners, we're going to cut down your trees, or you'll have more neighbors, or something., or for a while you'll have more traffic. Again, it has to be some inconvenience, which they would have been happy with had it been something they moved into and was capitalized in the price, perhaps. Say a bit more about David Ricardo. How do you find him as a mind? Do you think, gee, this guy's a lot smarter than I would have thought, or what an idiot, or he's very confused? How is it?

I think it's fascinating to read the smart people of the past because you see them sometimes engaged in what seem like, you know, like laughable errors or just weird— like there's this whole thing near the end of, you know, Political Economy and Taxation where he's in an argument with Adam Smith about whether or not we should price everything in terms of corn, you know, which seems like a sort of bizarre debate to be having. But it also makes you think about, you know, the fundamental questions in a way that gets escaped, you know. I mean, this whole, well, I mean, again, even the corn issue, you know. I mean, what is really valuable, you know, money and what things are used for. And all in all, I actually think it's pretty impressive that by talking about with almost a simpler world, you get to the core of things in a clearer way than a lot of contemporary accounts.

You know, in my view, Ricardo was very, very smart, and it's remarkable how well his intuition behind his models corresponds to what you can actually model, even if it's not in every way realistic. And all those discussions about corn I think he's looking for a way to close the system. That he sees corn as both an input and an output. So corn feeds workers and then workers produce more corn. So if you think of things in terms of corn, you understand and derive and pin down the real rate of return in the system and whether that's rising or falling or whatever. And that you need this kind of commodity bundle. And he's more consistent on that than Smith in a way. —In Smith, rates of return, I think, are more determined by supply and demand. But for Ricardo, it's more about science and technology of growing corn and the scarcity of land and how much does the marginal piece of land yield you. It's a very kind of rigid, unforgiving model that imposes its will on you and you have to live with what it coughs up.

—Right. Right. No, and it's— there's a real— I mean, there's an appealing, I think to me, you know, starkness and simplicity about it that, you know, you either get better at growing corn, you get worse, you have a better piece of land, you have a worse piece of land, the people, you know, either have enough food to have children or else they starve to death, you know, kind of simple thing. You know, I don't know in the end how much it really has to do with today. But I do think that, you know, there's something to the emphasis on rent as a really, you know, as a non-marginal element of the economic world that, you know, I think matters now that, I mean, so much of life is regulated to one extent or another, and we seem to have a lot of, to me, growing pressure on health, education, housing, sort of the most regulated-up sectors of the economy. That's really where the action is in terms of, you know, things that could make people's lives better.

I think Ricardo thought very deeply about diminishing returns, and he sees diminishing returns as the most fundamental fact about an economy. And I thought about Ricardo a lot when I was writing The Great Stagnation. I think in a way The book is saying a lot of aspects of Ricardo are correct in the short term, not in the longer term. In the longer term, there really are these bursts of increasing returns, and they will come again. And if you think of Ricardo historically, in the early 19th century, growth was often quite slow or mediocre, and especially for the average family. The Industrial Revolution was not quite the bounty of plenty right away that people sometimes pretend it was. A lot of the real growth comes later in the second part of the 19th century. Ricardo completely missed that, but diminishing returns was correct for some number of decades. He was the person who thought through most carefully what diminishing returns mean. See in Malthus. I think they're both still worth reading. You should also read Malthus if you haven't already. Not just the population essay, but Principles of Political Economy.

I will look into that. To it. Now do you think it's possible that diminishing returns in the realm of ideas is at some level just a brute fact, that there's not that much more to learn about the universe and, you know, you can sort of bring people up to the frontier, but the frontier, you know, there's just not that much further to go?

Maybe at some very, very distant margin, but I don't think in a way that's relevant to us. First, some of the problem is political and at least in theory could be fixed. But even putting the political issues aside, if we look at science, I think there are a number of frontiers we're knocking on right now, especially in the biosciences, like genome-based medicine. There's nothing in it that is making me better off now or is likely to make me better off in the next 10 to 20 years. But it's a live wire in a way that it wasn't a few decades ago. And I think this or something like it will lead to another burst. And we're not that far from it. Life extension also. It's not that I think cryonics is going to work, but people are living longer. And to think there's some other breakthrough where we figure out the immune system, cure cancer, and extend lives to say 120. I think that's entirely plausible. Curing obesity—

Yeah, so I mean, I would say that, you know, besides the internet, that we have had in the past 30 years some very significant pharmaceutical advances. That, for example, you know, we have antidepressant drugs that are much more impressive than, you know, treatments that were available in 1970 or so, but that I think it's probably right to say that sort of at the median that hasn't necessarily touched people, but it's possibly a window into the kinds of things that could be possible.

That's right. I think another factor, when you look at progress in medicine, which of course is real, a lot of the benefits there are concentrated on the elderly, which is fine, of course. But again, when you look at the median, when you look at the median voter, when you look at the political economy of the climate of opinion, The fact that the benefits are so skewed, I think it does matter. And if you're some, you know, 43-year-old guy with a house in Toledo, Ohio, and a so-so school system, even though you may get an extra year and a half of life when you're, you know, 82 instead of dying at 79, it still matters for a lot of social problems that there's been this growth slowdown. Even though at the end of your life you may get a big payoff.

Well, and I mean we have a, you know, funding of treatments is very balanced toward the older end when there's less, you know, just sort of cost-benefit payoff. That's right. If you're going to be equal, it would be better to treat like 15-year-olds.

We should spend much more healthcare resources on younger people in my view.

Right, I mean, because there you get the progress where it's not just that the better health is a better outcome, but that then the people go on and you get more second-order effects.

Sure, it's a much higher return, and you're also saving more innovators for that matter. Right. So Mozart and Schubert die at very young ages, and they could have composed a lot more music, but we didn't get it.

So, I mean, again, there's obviously politically the possible fruit to be gotten by redirecting resources from the elderly to children is extremely difficult. But I mean, it's potentially, you know, big, big gains to be had there.

Well, I think politically what it really means or will mean to have a society with so many old people is a topic a lot of sources have covered. But I've never seen anything really good and convincing on it, and I think it's quite an unprecedented experiment. At what margins, if any, will the elderly be willing to vote against their own interests? I don't have a good answer to that question. I hope the answer is at some. But if there really is a stranglehold of the elderly over politics in most of the frontier countries, I find that very worrisome. It'll have some big benefits, like the elderly are much less likely to support going to war, it seems, and that's a huge benefit. Right. But the notion of settling into John Stuart Mill's stationary state, I don't think that will happen. But I worry that it becomes more likely as the average age goes up, and part of that is political.

I fear a giant cohort of retired baby boomers with nothing to do all day. Starting blogs and undercutting me.

I don't think you need to worry about that. I fear that they spend their time in politics, and whether they're left-wing, right-wing, not that many of them will want to restrain the rate of growth of Medicare expenditures, if any of them.

Well, see, that's more gloomy.

Yeah, but I think your blocking status is secure for the foreseeable future.

Well, I hope so. That's why I'm trying to stay ahead of the curve. Read the old books, do the Bloggingheads episodes. Gotta keep pushing the frontier forward.

People don't blog enough books, in my opinion. There's far too much blogging of online news articles of the day, which is fine. Of course, they need to be covered, but there's an overcrowding. There's like an externality.

Right. That was my conclusion, is I had to differentiate more. Think about what are people not writing about.

Yeah. In terms of my posts, I've tried to do that for a long time. To take advantage of the fact that I can read a lot of books fairly quickly and just give some sources that not everyone else is looking at. Makes sense.

All right, I should probably wrap this up.

Okay, let me just read off the full title of my book because I forgot to do that at the beginning. It is Tyler Cowen, The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, And will eventually feel better. It's an ebook. It's available on Amazon. You don't need a Kindle to read it. You can download it to your computer, convert it to PDF. You can get a free e-reader from Penguin. It's $4, 15,000 words. And Matt, thank you for spending the time today. Much appreciated.

Thank you. Okay, take care. All right. Bye. Bye.