Real Wealth or Another Bubble?

Charlie Deist: Let’s hear from another caller, John.

John: I have a question for the professor. I assume that housing values and stock values represent much of the wealth in America and those values have fluctuated widely in the last ten years from high to low, now to very high. Has our society gotten wealthier or is this purely a monetary phenomenon? I’ll take the answer off the air.

Brad DeLong: Has our society gotten wealthier? Well, I would say yes and no. I would say the best way to look at it right now is that high stock and housing prices more reflect a low expected private rate of return on investment so that companies that have earnings right now — plus some that don’t like Amazon, plus houses that are built and are providing satisfaction to human beings — have a relatively high price relative to currently produced goods and services because there’s little opportunity to build new buildings and take new machines and use them to create enterprises that will be equally profitable. In one sense, it reflects not that we’re rich now so much as that we’re not expected to become that much richer, faster in the future.

You can go down to Silicon Valley and find Google’s Chief Economist Hal Varian, and he’ll say that what’s really going on is we’re becoming more prosperous at an amazing rate. Look at how much people like their cell phones, look at access to information and communication. It’s just that these particular sources of human well-being are not ones that are really being created and transferred by the market process. That is, that rather than selling what it produces, which is information, Google is running off of the fumes created by selling your eyeballs to advertisers, and the value it earns by selling your eyeballs to advertisers is much, much less than the value you receive from the access to information that Google gives you. So, the fact that it isn’t expected that future investments will be very profitable doesn’t mean that they won’t be very productive or very welfare-enhancing, but Hal is a minority point.

The majority point is that we seem to have entered a world in which people are less optimistic about the future of economic growth than they were. That’s the thing that’s pushing up housing prices, and currently installed housing prices and current stock prices, because those companies have made their investment. What it’s really saying is that investments in the past were more valuable than the investments you make today, and that’s why they’re so high.

There’s a second sense in which high housing prices in greater San Francisco are a sign of our poverty. That is, in a better functioning world — in a world without my crazy NIMBY neighbors — there’d be no way that the neighborhood of Elmwood (a mile south of the University, a mile north of the Rockridge BART) would still be composed overwhelmingly of houses like mine rather than of triple-deckers like the small apartment buildings surrounding Harvard, or like the ten-story apartment buildings surrounding Columbia, or like the 25-story stuff surrounding NYU.

Given the population of greater San Francisco, if development in the land of Silicon Valley had followed the standard American pattern, we’d have seen its population grow from five million to ten million over the past 25 years. Instead, it’s only grown from five to 6.5 million due to NIMBY development restraints. That means that the houses that exist are extremely valuable. But the reason they’re so valuable is because they’re so scarce. It’s a monopoly rent. And we’re poorer by the fact that we ought to have 3.5 million dwelling units in greater San Francisco that we do not have because we have seriously screwed up our land-use governance over the past 25 years. All of this is a standard economist’s answer: on the one hand, on the other hand; yes and no.

Charlie Deist: Right. Another axiom that economists are fond of is that there are always trade-offs. One of the points that the Austrians maybe internalized, but maybe still need to incorporate into their thinking is the idea that planning has to take place at some level. There’s no such thing as a purely neutral zoning policy, for example, and if we want to come up with the ideal regulations, well, maybe there is no such thing as an ideal regulation, because there will always be trade-offs. So economists have to be the wet blankets to inform people that they can’t have everything that they want.

Frontiers for the Aspiring Austrian Economist

Charlie Deist: I want to come back to what you were saying about Hal Varian and this world where more of the value is coming from our smartphone and information technology. On the one hand, this can give us an incredible amount of satisfaction. I’ve found blogs and Twitter and all these things to be a source of incredible education. But it’s a mixed bag, and in this new economic system, maybe there’s less emphasis on physical stuff and things.

The Austrian business cycle theory places a big emphasis on these long-term capital malinvestments — these are the areas where we tend to see inflation having the greatest effect. We get inflation from the long-term investments because cheap credit encourages a more roundabout production process. Hayek talks about the structure of production, meaning certain investments take longer to materialize, and if we’re injecting money into credit markets first, then you will tend to incentivize people to develop longer-term things.

Is there any kind of application for that model in your mind to the current world that we live in? Most of these Austrians were writing well before the 1960s. Hayek and Mises were early 20th-century economists. Is there anyone doing work in your mind that brings these ideas into the 21st century? Or, what areas do you think would be most fruitful for someone who is interested in an Austrian approach to pursue?

Brad DeLong: Well, with respect to that of over-investment in the structure production, I think the Minskyist current is winning and is the most productive one to pursue now. That is, if you’ve made investments and if you did make them assuming long-term interest rates will be lower than they in fact are now, and if they are now unprofitable, that doesn’t mean we should shut them down. To say we should shut them down is the sunk cost fallacy, to which I think Hayek and Von Mises fell subject to, to a large degree. What it does mean is that our future investments should be focused on things that have short-term payoff.

Then the question is, “Well, if we shouldn’t shut down long-term investments that are now unprofitable because we’ve already made them (and we might as well get something out of them), why is the reaction to a period of prolonged sub-normal interest rates a depression?”

The Minskyite answer is that it’s the financial system that messes up — that there’s no good way to quickly allocate the losses. The core of it is the fact that losses have not been allocated, and people wanting to commit new money are scared their new money will go to pay for old losses. And that, I think, is a very fruitful line of investigation . It’s not so much a hangover of excess buildings and excess machines, because we can always find uses for buildings and machines. It’s a hangover of bad assets — of bad debt that somebody is going to have to pay, or swallow and eat , and social disagreement over who has to eat them. So, I would say investigating the structure of bankruptcy and principal–agent finance, and how to quickly resolve situations in which debts go bad is the most fruitful thing to pursue.

If I can also give a commercial, I had dinner last week in San Francisco with a guy named Jerry Taylor, who used to be a vice president at the Cato Institute, and he now has split off and has his own libertarian think tank called the Niskanen Center in Washington D.C., which has a lot of smart people doing a lot of interesting thinking. If you’re looking for a set of people thinking and arguing about libertarian ideas in the 21st century, and want to put them on your Christmas list, I think the Niskanen Center ought to be first among your choices.

Charlie Deist: Would you characterize them as a moderate, centrist, technocratic libertarian perspective or … what is their byline or subtitle?

Brad DeLong: Their byline is to explode the center and to kind of ask, “What does libertarian mean, not in the 19th, not in the 20th, but in the 21st century?”

Charlie Deist: I had also hoped to ask you — this is one of those questions that I could talk about for hours, and we’ll just have to keep it to a few minutes — but to your mind, what is the difference between a liberal and a classical liberal, and do you identify as one or the other, or both?

Brad DeLong: The shortest way I’d put it is this:

Suppose you’re locked in a cage and suppose there’s a key that someone outside the cage is holding. The classical liberal would say, “You’re free as long as there’s a key and there’s somebody you could buy it from.” A New Deal liberal would say, “Wait a minute, you’re only free if you have the money to buy the key from the person holding it.”

I would say I’d identify myself as a modern liberal — a New Deal liberal — for that reason, but I’d also say that New Deal liberals, traditionally, have an appalling disregard for the magnitude of government failure and for the damage caused to the economy by rent seeking.

If I find myself in a group of too many social democrats, I’ll actually start calling myself a neoliberal. And if I find myself in a group of too many liberals, I’ll start calling myself a social democrat.

Charlie Deist: A natural contrarian — I like that.

If you are interested in following Brad DeLong’s work, you can find him at bradford-delong.com. He’s also on Twitter at @delong.

We’ve just spent the hour discussing the Austrian theory of the business cycle, in contrast with the Keynesian perspective, as well as the Friedmanite, the Minskyist, and there are probably many other perspectives that we didn’t get to. Anyone who’s interested in this area can get online, do their own homework, and form their own conclusions. We’ve been fortunate to hear from someone with nuanced perspective, and who can treat this issue with the full intellectual weight it deserves. Once again, thanks Brad for taking the time to talk with me.

Brad DeLong: You’re welcome. It’s been a great pleasure.