0:33 Intro. [Recording date: November 30, 2017.] Russ Roberts: Today, Brink Lindsey and Steve Teles will be discussing their book, The Captured Economy: How the Powerful Enrich Themselves, Slow Down Growth, and Increase Inequality.... Now, in the beginning of the book you wrote--here's a quote: The rise of inequality is, to a significant extent, a function of state action rather than the invisible hand. And this state action, by suppressing and misdirecting entrepreneurship and competition, has rendered our economy less innovative and dynamic as well as less fair. Now, I want you to expand on this central idea of the book and give us a short sketch of the argument. Bring, why don't you start us off? Brink Lindsey: Here in the 21st century the U.S. economy is suffering a kind of double-whammy malaise. Inequality, rising inequality, particularly with increasing shares of total income going to a favored few at the very top, and also slow growth. The average growth rate so far in the 21st century has been about 1%, in terms of annual growth in real GDP [Gross Domestic Product] per capita. That's half the growth rate that was the average rate during the 20th century. So, we've had a precipitous growth slowdown. At the same time the benefits for growth are increasingly skewing to favor only a relative few. Put these two things together, and you have dimming economic prospects for large numbers of Americans, and gathering frustration, resentment, and despair over economic prospects and over political institutions that are delivering poor economic prospects. These phenomena, slow growth and high inequality, are extremely complex; there are many causes. We do not present a mono-causal, silver-bullet analysis. But we do say that there is an under-reported, underappreciated aspect of these problems, and that is government policies that are actively making matters worse on both fronts. So, we identify government policies that are simultaneously bad for economic growth by stymying competition and distorting market forces, and do so in a way that redistributes income and wealth up the socioeconomic scale. Russ Roberts: Steve, you want to add anything? Steven Teles: Yeah. The core of the argument we have--and I think there's a point both on the Left and the Right that we address. Part of it is, on the Right there is often a discussion of rent-seeking and government distortion; at the same time people on the Right generally see their role as defending the moral status of the distribution of income. And, our argument is that if the first part of that is true--the government has a large, distorting role through regulation and other kind of market constraints--that must have an effect on the distribution of income. And, our argument is that there's very substantial evidence, that we put in the case studies, that those distortions of markets have generally been very strongly skewed over the last 30-40 years, upward. That's affecting the distribution of income as well as slowing down innovation. And therefore, the distribution of income is something that people on the Right should feel that they can address as an independent issue of inequality, without thinking that that somehow violates some underlying set of normative principles that they hold. Russ Roberts: And, before I go on, I think it would be useful to listeners for each of you to give a 30-second or 10-second sketch of your own ideology, to the extent you have one. You can say, 'I'm ideology-free.' Most of us aren't, of course. But, I think one of the things that makes your book interesting and your work interesting is that you don't see the world exactly the same way. So, Brink why don't you start? Brink Lindsey: Yeah. I come from the libertarian world, and I'm a kind of quirky, soft libertarian; I sometimes call myself a Liberaltarian. But even though at the Niskanen Center now, I wrote this book as a Vice President at the Cato Institute, which is the premier libertarian think-tank in Washington, D.C. Russ Roberts: And Steve? Steven Teles: And I consider myself as, like Brink says, a sort of soft libertarian; and I consider myself I guess a soft Liberal. I have always had a more redistributive view of fairness, but have also always been skeptical of the ability of government to always vindicate our normative principles. And that tension, which you addressed in our conversation about kludgeocracy, that tension between a normative belief in a fair distribution of income and a political or institutional belief that government's not always very good at doing that is the basic tension in my Liberalism. And that may be what pulls both Brink and I toward something like what we call Liberaltarianism. Russ Roberts: And just to let my cards on the table--listeners are probably pretty familiar with where I stand on these issues that we're going to be talking about--but I liked how you framed it, and I just want to add a couple of things. As listeners will know, I'm quite skeptical of some of the empirical claims about the growth in inequality. I think they've been distorted. Not just the growth of inequality, but the growth of wellbeing of the middle class. And I think those claims have been distorted by various changes in America that are not related to the economy: changes in family structure as well as the challenge of measuring price changes accurately, which means that, after we correct for inflation we often, I think, misunderstand what's happened to the standard of living over time, for the middle class, say. At the same time, I don't want to defend--you used a very interesting phrase, Steve, the moral--I think you called it something like the moral dimensions of the existing distribution of income. I'm agnostic on that. More or less. I understand that many people are born with great advantages that they're not entitled to, and suffer through handicaps that weren't their fault. And so those have huge effects on how the distribution of income that we see in the real world comes out. And I don't want to make any moral claims for that. My tendency is to focus on the fact that you also you do, Steve, which is I don't think the government does a very effective job in changing that. And I'm not sure its desire, its efforts to change that are motivated by what some people think. So, that's my approach to these issues.

8:03 Russ Roberts: Before we go further, I'd like to hear one of you--we'll start with Steve and you can hand it over to Brink if you prefer. But, Steve, give us the standard argument from people who argue we shouldn't do anything. What's their explanation for the causes of the growing inequality? What's the standard sort of market-based argument for why we're seeing growing inequality as opposed to, say, because of government intervention? Steven Teles: Yeah, and so, again, just to reiterate the point Brink had: that ours is not a mono-causal explanation. We're not arguing that everything or even the majority of growing inequality is a function of the kind of state action we are talking about. But, the standard argument, which again we think has some value, is, part of it is globalization. Right? As markets increase in scale, the gains that can be had by the biggest winners increase proportionately. And I think there's something to that, right? We have had a globalization in the economy; we do have people who can sell their skills and firms that can sell their products over a global scale; and that's obviously going to influence inequality. The second thing which Brink dealt with in his book Human Capitalism is that the returns on skill, both domestically and internationally have gone up. That's a function of changes in the technological structure of the economy. And that is driving inequality. So, both of those--those are, I think, the standard, mainstream economic profession tends to emphasize those two elements. And we think they are both important and relevant. Some of those actually have more state distortion than you'd think. Certainly the human capital production process is deeply embedded with state action. But, in general, that's what I might think of as the standard story against which we're saying that's incomplete if you don't take into account the ways that market structures have actually been actively distorted by various different forms of, captured by the wealthy and the already advantaged. Russ Roberts: Brink: What would the Left say? The Left's argument would invoke a phrase that you used at the beginning of your introduction, which I strongly disagree with--in general; I certainly recognize it in certain circumstances--which is that many gains, much of the gains from growth have accrued to the "favored few." To take the opposite side of that view, Sergey Brin and Larry Page, graduate students who eventually developed Google--they weren't the "favored few" who put a ring, some kind of fence around their wealth and made sure they gained more of everything. They vaulted from the bottom of the income distribution to the top. And that was through a variety of things that government was involved with, of course; but, it wasn't like there was some conspiracy that they manipulated the government to give them advantages that allowed them to get very wealthy. You can react to that if you want, but make the general point-- Brink Lindsey: I agree wholeheartedly. That's my reaction. Russ Roberts: Okay. React--but give the general argument that the Left makes about the causes of increasing inequality. Brink Lindsey: Yeah. So, Steve talked about a kind of blind spot on the Right, where people on the Right simultaneously believe that the economy is being deranged by excessive government intervention and at the same time that the distribution of wealth is fine and that the people at the top are all makers and deserve their money and should have low taxes because they earned their income-- Russ Roberts: They built it. Brink Lindsey: Meanwhile, there's kind of a corresponding blind spot--and those two beliefs don't really fit very well together. There's a corresponding blind spot on the Left, which is to believe that inequality is the natural result of market forces--that's a very sort of ideologically convenient belief for the Left because it then calls, highlights the need for strong, active government to counteract and restrain the market. But, Progressives are quite alert to this power of the rich to influence and game the political process. But that, then, is in tension with their belief that this is all natural market forces or capitalism run amok. It's a kind of a strangely restrained view of Plutocratic political power they have, which is: the Plutocrats dominate the rules to make them purely neutral so that market forces rip[?]; and when those market forces rip[?], the rich come out on top. Of course, if you have that kind of power you are not just going to write neutral rules. You are going to write rules that favor yourself and rig the market in your favor. So, here, again, there is a kind of implicit tension in two beliefs that the Left holds. We resolve both tensions on the Left and the Right by pointing out that there is a largish area of public policy where government is slowing down growth and exacerbating inequality simultaneously.

13:44 Russ Roberts: So, I think that's a little unfair to the Left. I want to give the Left's position, if I might. Which overlaps with a lot of the themes in the book. So, in some sense, there's a strong, Left-leaning, interventionist theme in the book of, mainly, removing interventions that have favored the rich. But, I think the Left make a stronger critique, that I didn't see you deal with. So, I'm going to start with that. The Left argues that there's too much political power--there's too much power among the wealthy. They have two kinds of power. They have economic power, because they have these large economic organizations that allegedly exploit customers or take advantage of some kind of pricing monopoly or ability to raise price and keep revenues flowing and profits flowing. So, there's economic power. Large corporations wield economic power, they would argue, particularly on Wall Street. And then they would also argue the part that you mentioned--that they also wield political power. So, I don't think they see them as-- Brink Lindsey: No; that is quite right. Of course, the Left is quite clear that the rich wields political power. But, they tend to see how the Left uses that power in very incomplete terms. That is, they see-- Russ Roberts: You mean the rich. Brink Lindsey: Excuse me, that the rich use their power to keep taxes and regulations low. Basically to get government out of the way so that they can accumulate wealth. What they miss is that, if you've got all that power, you don't just use it to push government out of the way. You use it to recruit government to be an active agent of your own enrichment. Russ Roberts: Well said. Brink Lindsey: That's the part they miss. Steve, do you want to comment on that? Steven Teles: Yeah. And I think another way to think about that is that the argument, you know, going in a way all the way back to Marx, is that capitalism has an inherently concentrating effect: the more that you get rid of informal or formal constraints on markets, the broader the scope for inequality. And therefore, if you want to reduce inequality, the only way you can do that is to somehow throw sand in the gear to the machine. Right? And, so, regulation is generally positive in this view because it reduces the scope for markets to turn everything solid into air and produce that potential for worldwide inequality, not just within the nation-state. And, I think our argument is that markets actually have some countervailing effects. Right? Now, where there are supernormal profits of various sorts, where you got the potential for market entry[?], that creates the opportunity to at least compete away some of those supernormal profits. As a result of that, people who have advantages are going to try to lock them in through state action. They are not just going to try to create an entirely free market in which they are able to scoop up all the gains. They are going to try and keep out those who would challenge their various forms of supernormal profits. And I think that's the area where, in general, we think the Left has a blind spot. They don't actually see at least some of those countervailing forces that markets properly organized have, in a way that advantage interests actively try to gain markets, not just to keep regulation out but to use regulation as a weapon against their competitors and against outsiders. Brink Lindsey: If you look at the scholar most associated with the inequality issue on the Left, Thomas Piketty, here, he presents this view of capitalism's natural tendency towards concentration and inequality very starkly. For him, it's just in the DNA [Deoxyribonucleic acid; inherently built in--Econlib Ed.] of capitalism that, because r>g [r=rate of return on capital; g=growth rate--Econlib Ed.] there is this innate tendency; and only wars and revolutions can temporarily interrupt that tendency. So, in Piketty's vision there's just no politics or institutions at all. There are these deep, primal economic forces that are pushing us towards inequality; and we believe that misses a whole bunch of the picture. Russ Roberts: And, r>g is return on investment relative to the growth rate of the overall economy. And, of course, I interviewed Piketty, and we'll put a link up to that episode for our listeners who want to hear that and find out more about those ideas.

18:23 Russ Roberts: The part I thought you are missing--that was a nice summary by both of you, but the part I thought you are missing is, the Left then goes further and says, 'And therefore, we need to get the rich out of the political system. They have an unfair advantage, because of the donation process. And we need campaign finance reform.' And I don't think you talk about that. My response to that is always, 'Well, if government had less power, it wouldn't be worth buying.' And then, we wouldn't need campaign finance, or that campaign finance reform is very difficult to enforce, and we'll encourage other types of influence by the rich that will be less transparent. That's my argument. I don't know if it's a good argument or a bad argument. But, I'd like to hear your reaction to that. Brink? Brink Lindsey: Well, we do address the campaign finance issue in passing by saying that we think that is a kind of distraction from the most effective and constructive approaches towards limiting special interest influence. So, both the Left and the Right worry about special interests dominating policy-making. They have different ideas of who those special interests are. The Left, in particular, worries about the rich dominating the process; and they worry about campaign finance as the main vehicle for influence. So, there's a great deal of focus on kind of stopping the lobbying. Stopping the money, controlling the interests that are trying to influence the government. We think that a much more constructive approach is to fortify the government and make it less vulnerable to and less dependent upon the special interests that are lobbying it. And, in particular, the main source of dependence that the government has on interest groups is policy-relevant information--the data they need to draft laws. Maybe Steve can follow up on this a bit more. But, because, at the precise time that the scope of government has expanded, and the complexity of government regulation has soared, the analytical capacities within both the legislative and executive branches have not only not been keeping pace, but have actually been shrinking. So, that, when the government is making policy, it is deeply dependent on the interested parties that are being regulated for the information they need to govern. Using that informational advantage is a huge tool that special interests can get to make rules come out in their favor.

21:09 Russ Roberts: So, Steve, I want you to add to that. But, I think, just to emphasize the point: The book is called The Captured Economy. And the idea that regulators are captured by the industries they are supposed to regulate goes back to--well, it probably goes back to Adam Smith. But it's associated today, for me with George Stigler. It's also associated with Joseph Stiglitz, on the other side of the ideological spectrum among economists. And that--this idea that it's not just a revolving door problem, but a problem of information control, is very interesting. So, why don't you expand on that? Steven Teles: So, I should say, first of all, that, at least my view is that the standard regulatory capture argument is overdrawn. In that regulatory capture is a thing--right? It's actually something that happens. But it's not a universal or iron law of government. Government agencies and government functions actually vary systematically in terms of how susceptible they are to be captured by affected interests. So, that's one thing to say on that. On information, I think one of the arguments we have is that, typically, when people think about lobbyists, they overemphasize their sort of coercive power--right? The fact that they can use money to bend the actors to their will. And I think the evidence of that is a little thin, in Political Science. And therefore, there's an overemphasis on campaign finance. On the other hand, however, there is a underemphasis on the ability of organized interests to influence the organizational environment that policy makers face when they actually make decisions. And that's on two levels, right? Brink emphasized the level where policy makers are, something's on the agenda and then they are trying to decide what to do. And then, they, the scope of what they do is influenced by the information that they are able to get from either outsiders or insiders. And that's important. But there's another which sociologists are referred to as the second face of power. Which is, the--whether or not a particular area is, even consider a particular idea, is even considered to be what Jack Balkin has called 'on the wall,' or whether it's 'off the wall.' So, occupational licensing is a perfect example of this. Occupational licensing protects an enormous number of incumbent interests. It has all kind of distorting effects. It has all kind of distributive effects. But the thing that protects it most durable is the fact that any other alternative to occupational licensing is viewed as simply nuts. And, the people who have an interest in it have a very strong interest in preserving that idea. Right? Not even to defend the substance of the argument for occupational licensing, but to so marginalize any other alternative that they don't even have to defend the merits of their policy. You see that in a number of other areas. We have a critique in zoning. Zoning has often been viewed as something that only those on the very far Libertarian fringe have any problem with. And so, we think of information has got these two different levels. One is: Information matters on affecting whether or not alternatives are on the agenda or now. And, embedded interests are able to put a lot of resources into keeping ideas off the Agenda. And, it also affects on the other side that those who might challenge it, generally have less resources to invest in challenging those, what people on the Left would call, hegemonic[?] ideas. And then, secondarily, information matters: Even if you get an idea on the Agenda, it affects the scope of what policy makers think they can actually do; and especially what they can do without taking on substantial risks to themselves.

25:21 Russ Roberts: I just want to mention as an aside that, when you talk to people in industry, which I have done in my life--not as often as I wish I had; but it's useful for an economist to actually talk to people in the trenches--they'll speak with disdain of their regulators: that they don't know anything. And, they don't sit around and rub their hands together and twirl the ends of their mustache, thinking, 'Heh, heh, heh, I can take advantage of this.' What they do is they see the regulator is very uninformed about their business relative to themselves. Of course, they then have control over much of the information that the regulator receives. It's particularly true in finance--which we'll talk about in a minute. And as a result, there's a natural tendency--I don't think it's always sinister; I'm sure sometimes it's sinister, but a lot of times it's just they end up showing the regulators the information that happens to be, you know, conducive to less regulation. Or, regulation that benefits incumbents. Or regulation that helps them out in some way. And so, that's the process that I think you are pointing out that's very, very valuable to be aware of. Which I think is easy to miss. Which is: the world is very complex. It's always going to be the case that the people in the trenches--the people who actually build new products, the people who are actually creating the pharmaceuticals or designing the mortgage-backed securities will have a deeper understanding for all kinds of reasons about what's actually happening. But unfortunately they are also blinded by their own self-interest. So, they are not going to give the regulators the exact information that they would need to make great decisions for a larger set of interests. So, either of you can react to that. It's just my-- Brink Lindsey: Yeah, sure. There is no need to ascribe sinister motives or mustache-twirling to rent-seeking interests. I don't know if we've used that term, 'rent seeking,' so far. But that crops up a lot in our book. And by 'rent seeking' we simply mean pursuing profits through the political process rather than by adding value for customers. So, getting rules written in a favorable way. But, by and large, the interests that are trying to, you know, get their way on Capitol Hill in Washington generally, see themselves as aligned with the public interest. Most people don't--most people like to think well of themselves and they are very good at rationalizing how to think well of themselves. So, I'm sure that the people that are on the other side of the issues that we talk about, when they are--it's really--an important part of being an effective rent seeker is truly being sincere in your belief that what you are calling for is absolutely necessary for the public interest. So, we have disagreements about what that entails; but we don't need anybody to be actually scheming to defraud anybody or to be engaged in misdeeds. Pursuit of self-interest with partial information can lead us to where we are. Steven Teles: Yeah--I'd like to address just a point that Russ made. One way I think about this is: What are our assumptions about policy makers--the people who are actually making decisions? One is: Yes, there is this asymmetrical information problem that Russ is describing: that regulated know more than the regulator about their industry. Now, I think that's a variable rather than a constant. Right?-- Russ Roberts: Good point-- Steven Teles: You can imagine different ways of organizing government in which there would be less asymmetrical information. One of the things we emphasize is: One of the problems of a revolving door is not just that the people on the one side go over to the other side, but the people who are on the government side are often not around long enough to have heard all of the BS that the regulated have argued, and said, 'Oh, yeah, you guys always say that. And it never turns out to be true.' Well, if you are not there, around long enough to have heard all those stories, then you are not going to be able to see through that. So, I think that's an important part of the story. The other thing is that policy-makers, especially those in Congress, tend to be risk averse. Doug Arnold, going back to his great book, The Logic of Congressional Action, argued that policy makers, a). they are more likely to lose their seat than to fail to win it--right? They are more likely to lose a seat because they do something that creates negative effects that then can be traced back to them; and therefore they are highly worried that they are going to do something, they are going to make an action and then something bad's going to happen and then people are going to say, 'Oh, you caused that.' And that gives a lot of advantage to incumbent interests; because in many cases, all they are trying to do is defend the existing policy regime. And so, when somebody is saying, 'Hey, we should have a big capital requirement on financial firms,' all the finance people have to do is say, 'Oh, this is going to have terrible, awful consequences.' Right? And, 'They are going to be large; and they are going to be unpredictable.' And 'Therefore you should do something more modest,' or 'You should do a whole lot of small things.' This is one of the arguments I have for what produces kludgeocracy, which we've talked about before. And so, again: When government itself doesn't have a lot of internal capacity, or doesn't have countervailing organizations on the other side that can produce information saying, 'Actually, this measure you are talking about--getting rid of licensing of dentists or putting a capital requirement on finance--isn't actually going to have all those terrible negative consequences.' When that doesn't exist, it gives a very strong advantage to the existing, incumbent interests. Russ Roberts: I just want to add a couple of things, and then we'll segue into the four areas that you look at in the book, for where you think that government action has worsened inequality and hurt growth. The first is that, the role of economists--and I've talked with Luigi Zingales about this; I think it's an incredibly important point--which is that economists often reassure policy makers that they have no choice but to, say, bail out the creditors of a failed financial institution. That, without it there would be a disaster. It would be terrible. And, of course, all those incentives you talked about, Steve, come into play. The regulator does not want a Great Depression on his watch, 'his' being Ben Bernanke's. So, he's going to be very aggressive to make sure that things don't go very badly right now. Which means he can be setting the stage for something to go very badly in the future, that he will not be necessarily blamed for. Economists like to encourage that kind of change, because it makes them powerful. It makes them important. It creates demand for economists, to be steering economic stability, macroeconomic stability, financial stability. So, I just think there's a terrible, implicit collusion there. It's not explicit--[?] there's nothing sinister about it. But just the natural self-interest of the players pushes us in a particular direction. And similarly, staying with Finance for a minute, I was arguing with someone on Twitter the other day about moral hazard. And this person, who is in the investment business, said, 'Moral hazard is not important. Nobody makes bad investments expecting to be bailed out.' And I said, 'How do you know?' And he said, 'Because you ask them and they say it didn't affect them in the crisis.' And I said, 'Do you think it may be that they'd have an incentive to be honest or dishonest about that?' Why would you take someone's word for it? This system of being bailed out is unbelievably beneficial to the financial sector. It's the gift that never stops giving. And you are going to take on face value the claim that, 'Oh, no, that isn't why I kept making those bad investments. It was a just a rational exuberance.' So, I think these kinds of rationalizations that Brink talked about--I just think that it's a very, very important thing to be aware of when we think about what's really going on in the world.

32:55 Russ Roberts: So, let's move to Finance. We've covered finance a lot on this program, the kind of issues you raise. So, I want to talk about it briefly, and move on to the other areas. But, let's summarize what you are has gone wrong with state intervention in the financial sector, particularly because most people on the Left, the average American even, thinks that the financial sector, every once in a while it just runs amok. It just goes berserk and there's nothing that can be done about it. It's just reality. It's part of life, and that's the way it is. Brink, why don't you go first? Brink Lindsey: Yeah. We do not claim to do any kind of comprehensive survey of financial regulation. Our goal simply is to identify a couple of major areas where we think government policy is, through regulatory capture, having bad effects on efficiency and growth, and simultaneously regressive, distributive effects. And, here, in finance, the case that this is sort of active government intervention in the economy is harder to make because there is, other than in Scotland for a few decades in the late 1700s, there is just no laissez faire baseline in finance to judge interventions against. The modern state and modern finance co-evolved co-dependently. They have been inextricably connected since the get-go. And so, it's very difficult to find any kind of pristine laissez faire financial markets that then one would set as a baseline for, against which you would look at intervention. So, what we're looking at, really, is comparing different regulatory models and different regulatory systems, and seeing what those different alternative regulatory models, how they might work. The regulatory model that we've been sustaining for a long time is one where financial firms are highly dependent on debt for their financing. In almost all other industries, debt loads of higher than 50% of assets are considered to be problematic; and get your creditors worried; and get your stock price nosing down. Many companies have much lower debt loads than that. Apple famously didn't borrow at all until quite recently. But, in the financial sector, leverage of, you know, 95% of assets is commonplace. How does such a precarious and vulnerable funding structure persist, in which only slight decreases in asset values then make financial firms insolvent because they are so highly leveraged? It persists because of both explicit safety net for financial institutions because of the discount window and lender of last resort function for the Fed; and also, deposit insurance for depositors. And then, as you alluded to, Russ, this large implicit guarantee to bail out large or systemically important institutions that we've seen, again and again and again for decades, starting with the Continental Illinois bailout in the 1980s moving through the Third World Debt Crisis of the 1980s, moving then to the Mexican Debt Crisis in the 1990s, and the Asian Debt Crisis; the Long Term Capital Management bailout. There's been intervention after intervention where banks got in over their heads and government has stepped in to ease their pain, and has introduced whopping amounts of moral hazard into the system. The moral hazard operates, primarily, though, Russ, not on the decision-makers within the institutions. They may think that they are managing risks correctly; and they may have skin in the game and not be trying to make a bet with taxpayers' money. But the fact is, it's the effect of moral hazard on the creditors, keeping credit costs so low at such dizzying, high levels of leverage, that sustains this whole model. If we hadn't had this kind of persistent government propping-up of high leverage, we wouldn't still have it. So, it's persistence is an artifact of government policy; and it produces a financial system that is recurrently crisis-prone. Russ Roberts: Steve? Steven Teles: Yeah. The other dimension of this that I would want to emphasize is that, we often talk about the problem in Finance as the recurring crises and the bailouts. But government has also had a role in propping up the financial industry in a much broader sense. One that Brink didn't emphasize is the tax code. It gives a very strong bias toward borrowing, and that's very important for highly leveraged firms like in finance. The second is the way we've organized retirement savings. We have huge subsidies in the 401ks and IRAs that have encouraged a very large, active management industry in asset management. They have very large fees, for which there is no economic justification. Those are not the very highest parts of the financial industry--those are not the tippy-top of the 1%--but a lot of the bottom of the 1% are made up of those asset managers whose jobs are purely a function of the way we've organized retirement savings. And, so, there's actually a very broad set of subsidies and regulations that have propped up the financial industry and have caused it to be much larger than it would be in other cases. And, again, there's very substantial evidence from economics that, while a certain level of financialization is a good thing--you can definitely be under-financialized--the United States is very far on the other end, where financialization is actually associated with declining innovation. Financialization also ends up sucking up a lot of high-end talent and human capital; it causes a very big distortion of what the most-skilled, the most highly-trained minds end up doing. And that has a channel both into innovation and then, both, into inequality. Russ Roberts: There's a puzzle, there, though. And of course, I'm very sympathetic to those general arguments, across the board. And my essay, that we did an episode on, "Gambling with Other People's Money," will be coming out as a book soon. So, the excitement's palpable out there in listener-land. I hope some people look at it. We'll see.

40:55 Russ Roberts: So, I'm very sympathetic to that. The question is, you know: It's easy to make these kind of claims. I make them all the time. But, I think you have to ask, also--and for me, a better way to say this is, one of the costs of this is distorting the allocation of capital. You know, we put trillions of dollars--trillions of dollars--into houses. That just--it would have been better to put it into cancer research. Or, making a better electric car. Or, a thousand things that would have probably made life better than having bigger houses and more of them. Which, just doesn't seem--that was a distorted choice. But, then, the issue is--that's one thing. But the issue is, you are making a broader claim than that. And I make this claim as well, and again, so I am criticizing myself--which is that--and the opportunity to borrow money has made these institutions dramatically larger, has attracted, as you say, talented people into them. So it does raise the question of why the salaries are so high. I understand why the returns are high for the investors who have profited from this and the people at the very top who run these institutions. When they spent their own money, when they were partnerships, they were smaller and they made less money. Now they are larger, and they are compensated more generously--because it's hard to run a large organization and have that responsibility. But it's not just the handful of people at the top. It's people all the way down through the food chain of these organizations. And it's curious why their salaries are so large, given the claim that we're making that it's not that they're so skilled at what they are doing and they are doing all this great investing. It's more that they've just been subsidized to be able to spend other people's money. Which is lovely when you--nice work if you can get it. Do you have any thoughts on that? Steven Teles: Yeah. So, just as far as the salary disparity, it's quite arresting. Back, 30 years ago, financial professionals generally made comparable pay to comparably skilled professionals in other sectors. But now they earn a 50% premium. For top financial executives, they earn a 50% premium over comparable executives in other industries. So, there really is a really--this is an incredibly lucrative line of work. Why the industry hasn't grown enough to reduce those salary disparities--maybe there's just limits on how much financialization could then arbitrage away the salary differences, so you are stuck with those big ones. But, in general, the game is that, when times are good--the game is running excessive risks. Which gives you, in good times, very high returns. Those high returns then get channeled into the pay of all those people we are talking about. When times are bad, though, excessive risks turn into unnecessary losses. Those losses, however, are socialized. So, basically the financial sector is running one-way bets with pay. They get--they privatize the gains and they socialize the losses. And, financial--nobody else gets to do that. So, finance gets paid better because of these one-way bets. Russ Roberts: It doesn't explain, though, why, a bright--we are talking about this flow of human capital, which I think again is another of the really actually the more disturbing or destructive part of this. And I mentioned the allocation, the misallocation, of capital. It's the misallocation of human capital that I think, Steve, you referred to earlier, where some of the--for a long time now, in America, some of the brightest young men and women coming out of MBA [Masters of Business Administration] programs and out of even science programs have gone into the financial sector, because the pay is so generous. Which, you could argue--you know, that would be okay if they were actually making the world a better place. And, as we've all admitted they sometimes do--the existence of a financial sector is crucial. But the size of it, and the way it's structured is not crucial. And this is--to what may be a negative impact on our economy. So, the question is why they have to attract the best and the brightest to do things in the trenches are really not that difficult, not that transformative. They are not inventing the next autonomous vehicle, or whatever it is. Why is it that those pay levels attract those, or set at those levels--you'd think they wouldn't have to. So, there's something else going on there, I think, that those get competed away. Steven Teles: Well, let's-let me think about this, in one way. So, one of the questions is, going back to Brink's point about why are, is pay in the sector so much higher than it used to be. One way to think about this is institutionally--that, the way we organize finance is just a lot different than it used to be. One way to think about this is in the mortgage business, which is a huge, high-volume business. It looms very large in the whole area that we're talking about. If you go back 30 or so years, the basic way that we organized mortgage finance was through Savings and Loans. We had thousands upon thousands of them. Some of them were extremely small. The little town my mom grew up in in South Carolina had its own Lake City Savings and Loan that made mortgage loans mainly just in the town and outlying areas. And that regulatory regime, which was also obviously connected to Glass-Steagall, had the distributive effect of producing a lot of middle- and upper-middle-class bankers who could afford to pay their country club fees. When that blew up-- Russ Roberts: But they didn't, they couldn't afford to buy their own islands. That was-- Steven Teles: Right, but so let me get to the people who could afford to pay to buy their own islands. So, when the Savings and Loan regime blew up, we essentially substituted the mortgage securitization regime. Where, now--right?--we're still making lots of mortgages, but we've got mortgage originators, and then we have people who are trading mortgage securities. That's a much smaller group of people than in the previous regime. But, much more concentrated and more economically concentrated: a smaller number of them. They are much more geographically concentrated. They are not in Lake City, South Carolina. They are in New York and just a few other places. And so, you have a much more concentrated set of gains from one regime rather than the other. The other side of this, is, when you think about the asset management side, 40 years ago a lot of that asset management was in employer pension funds. That's a case where the employers of various sorts had a lot more leverage over the asset managers in setting what their returns were going to be, because they were large institutions that had that kind of bargaining power. As we moved to 401ks and IRAs and now you have all this proliferation of active management and asset management, if you look at the amount that they charge in terms of fees is a lot larger than the amount that was being charged to employers, to pension funds. So, both of those explain why you have a concentration and an increase in returns. And that affects the resources that firms can distribute internally to their own employees.

48:48 Russ Roberts: So, let's move on, because I want to at least touch on the other areas you talk about. So, finance is a big discussion in the book. You then turn to intellectual property and the patent system--copyright, etc. And most people would argue, in the abstract, 'Well, that's good for growth and innovation,' and that innovation is good for lots of people, not just the innovators, because those new products often benefit large swaths of the population. So, the standard argument would be, 'We need patents and copyright to protect intellectual property because without that we'll have less incentive for innovation. People's work will be stolen, copied. Their returns will be lower. We won't get as much as we otherwise would have.' What's your argument on intellectual property? Brink Lindsey: Yeah. It's definitely counterintuitive to classify intellectual property as an anti-growth measure, since its justification is to sweeten incentives for innovation. By giving innovators temporary monopolies and thereby raising their returns, the idea is to increase their incentives to innovate. And, that works. Right? There are benefits to intellectual property protection. Certain innovators are incentivized. However, also costs are imposed by these temporary monopolies. We typically think of the tradeoff between producers on the one hand and consumers on the other--that is, the consumers are having to pay a little extra because of these patent and copyright monopolies; but in the long run they benefit because they get more innovative products down the line that they are able to purchase that wouldn't even be available if it weren't for the subsidy that they are providing to innovators through patents and copyrights. But, there's also costs imposed on other producers. Downstream innovators. So, when you are trying to come up with some new invention and you need to use pre-existing ideas and recombine them in some novel way to make your new widget, patents and copyrights can block your access to those upstream ideas, make it more difficult to access them, and therefore discourage downstream innovation. What we've seen in the past 30 or 40 years is an explosion in the scope of intellectual property--[?] explosion in the scope of copyrightable material; explosion in the scope of patentable inventions. The number of patents issued every year is 5 times now what it was back in the early 1980s. And, as a result, the costs for downstream innovators have multiplied dramatically without any corresponding extra incentive benefits being delivered by the patents and copyrights. So, we see this as an area that's always had costs and benefits, but because of an explosion in these laws in recent decades, the costs have grown completely out of proportion to the benefits. So that now, especially in patent law, the main function of the law is just to create a legal minefield for innovators who can be shaken down by so-called patent trolls who buy up portfolios of patents just to weaponize them and litigate on them. So, what should have been pro-innovation policy is perversely turned into pro-lawyer policy. Russ Roberts: Steve, you want to add? Steven Teles: Yeah. I mean, the other effect on this, first of all, it plays into concentration. That is, the more you have uncertainty as to whether or not your innovation or the way you are using an innovation is going to be litigated--large firms have the ability to handle that in a way that small firms don't. Small firms can be very worried that their innovation or the product they have is simply going to be destroyed by a patent troll. And that encourages them to simply sell out to larger firms, or to never be created in the first place. The other thing about this is that it also plays into the inequality story that we're telling. A lot of, especially in the entertainment side, which is where on the copyright side, the beneficiaries are not usually little, plucky musicians. Right? They are very large, consolidated media companies, like Disney. Or, they are large recording firms who want to protect the benefits that they have from a few superstars and apply that globally; and so by extending copyright terms, that mainly ends up increasing the amount of profit they can get from that very small number of superstar recorders, or entertainers, without actually affecting the amount of people who are going in on the front end, which is the thing that really produces innovation, that produces new forms of creative productivity. Russ Roberts: We did an episode with Robin Feldman on this topic that I encourage listeners who missed it to go back and listen to, which was quite surprising again as an example of how, if you look a little more deeply into how the business actually work with the regulation, you get a much richer picture of what's going on. And she catalogs quite impressively to me how pharmaceutical companies have been able to use patents to extend that monopoly power for a longer time than they otherwise would. Through very creative and interesting ways that are not so good for customers--either patients or taxpayers who often are paying for the medicine.