The returns to societal capital

Posted by Dietrich Vollrath on December 26, 2016 · 9 mins read

Brad DeLong had a recent post that contained a number of ideas regarding how we view redistribution in a market economy. I picked up on some comments he made towards the end of that post, in which he points out that much of our prosperity comes from a stock of societal capital that we unknowingly rely on every day. And because that societal capital is unseen and uncompensated, we are all in some way overpaid for what we do.

When he says societal capital, I think of it in two broad categories:

  1. Trust: I think this is much of what DeLong has in mind. We are lucky to be in the “trust” or “cooperate” equilibrium in our repeated game of exhanging goods and services. If you like, call it the “stag hunt” equilibrium Nick Rowe talks about. Regardless, we benefit from the decisions of our ancestors to play this equilibrium, so that it is the default. If you want to say this is due to some institutions, or culture, or pure luck, it doesn’t matter. We’ve found our way to the trust equilibrium, and benfit from that immensely.

  2. Scale: He doesn’t mention this explicitly, but I think it is as relevant as trust. Scale influences the potential profits from innovations, and so is crucial to growth. Bigger market, more profits, more incentives to innovate. But scale is not the same thing as trust, or institutions, or culture. If you doubt that, ask yourself why no firm is spending millions to get into New Zealand, paragon of free market institutions, but they are falling all over themselves to do business in China. Living in the US, or EU, or China, is to reap the benefits of living with scale.

The heart of DeLong’s point is that neither trust nor scale are things that are owned by any firm or individual. You could say that we inherited them from our ancestors, or you could say these are emergent properties, or you could say that they are designed by the institutions we choose for ourselves. Regardless, trust and scale are “ideas” in the broadest sense, and are inputs into the production process in that trust and scale mean our set of rival inputs (labor, capital) can produce more with them than without.

How is it that scale and trust mean we are overpaid? Here I’ll borrow an idea from DeLong, and “hoist one from the archives” of this blog:

Just to refresh, a production function tells us that output is determined by some combination of non-rival inputs and rival inputs. Non-rival inputs are things like ideas that can be used by many firms or people at once without limiting the use by others. Think of blueprints. Rival inputs are things that can only be used by one person or firm at a time. Think of nails. The income earned by both rival and non-rival inputs has to add up to total output. Okay, given all that setup, here are three statements that could be true.

  1. Output is constant returns to scale in rival inputs
  2. Non-rival inputs receive some portion of output
  3. Rival inputs receive output equal to their marginal product

Pick two.

The ideas of trust and scale are non-rival inputs to production. If we assume that output is constant returns to scale in rival inputs (point 1), then we have to pick wither 2 or 3. As neither trust nor scale receive payments, we have essentially chosen 3. And in that sense DeLong means that rival inputs (our labor and our capital) are overpaid. We are not compensating anyone for the trust and scale that we inherited or created as a group.

A first aside is that in my set-up choosing 3 implies that rival inputs earn their marginal products, and DeLong is saying that our labor is earning more than its marginal product. I don’t think this is actually a meaningful difference. DeLong is saying that labor is overpaid because it earns returns that could be going to ideas like trust and scale. Whether we say that what it earns is the marginal product or not is irrelevant.

A second aside is that it isn’t really as stark as saying we chose option 3. Some ideas - the patent for an iPhone, the trademark on Coca-Cola - are protected and receive compensation. All I’m saying here is that scale and trust are ideas that are not receiving compensation, and in that sense rival inputs like labor are overpaid.

A third aside is you may be wondering how the increasing returns to scale that DeLong mentions fits in here. Note that point 1 only says production is constant returns to scale in rival inputs (labor and capital). In terms of all inputs (labor, capital, and ideas) production is increasing returns to scale. If I doubled all of them, output would more than double.

Back to the main story. What DeLong does with this is to provide what I found to be a unique justification for the public sector. That is, taxes are a way of collecting the royalties on trust and scale that we inherited and/or create ourselves. Taxes are the rents to idea of playing “cooperate” or having scale. And the proper use of those rents, if I am reading him correctly, is in ensuring that those endowments are perpetuated and handed off to our own children.

What does it mean to perpetuate trust and scale? Part of it, I think, is in providing the insurance against the fluctuations that are the necessary corrollary of the markets we create with trust and scale. Those fluctuations play havoc with local communities and ways of life, a la Polyani. Hence individuals or communities may be tempted to defect from the cooperate/trust equilibria, or hive themselves off on their own and reduce the scale of the economy. If we spend the rents of trust and scale supporting those communities, we can incent them to stay in the good equilibrium.

The issue with this, as DeLong spends most of his post working out, is that simply handing out those rents to people creates issues for everyone involved. Those paying taxes feel that they are being taken as suckers. Those receiving the rents - the members of disrupted communities - feel like deadbeats. No one wants to be in either of those positions. We have built-in preferences that make deviation from trust and scale look attractive. Which is why being in the good equilibrium is such a delicate thing.

How then, do you justify the collection of the rents that, arguably, rightfully belong to all of us, and ensure that we pass on the trust and scale necessary for prosperity to the next generation? And do so in a way that is palatable to all parties?

One idea is that you can use the idea of rents or royalties as a positive justifcation of taxation. We are collecting on the royalties due to us as a citizenry for our trust and scale, the same way that Apple collects royalties due to them as a designer of useful touchscreen emoji delivery machines. In this concept, taxation is not theft, or a necessary evil, but rather the enforcement of our intellectual property rights over trust and scale.

On the other end, the distribution of those rents is perhaps more palatable when seen not as a handout (which makes people feel like a deadbeat) but as something like a dividend on shared ownership of an asset. I feel like this would be one way to think of how a universal basic income could be framed - everyone is getting their share of the collective dividend payment due to the owners of the “ideas” of trust and scale. It is a sign of ownership, not dependence.