Robert H. Frank is the Henrietta Johnson Louis Professor emeritus of Management and Professor emeritus of Economics at Cornell's Johnson Graduate School of Management and a Distinguished Senior Fellow at Demos. For more than a decade, his "Economic View" column appeared monthly in The New York Times. He received his BS in mathematics from Georgia Tech, and then taught math and science for two years as a Peace Corps Volunteer in rural Nepal.
He holds an MA in statistics and a PhD in economics, both from the University of California at Berkeley. His papers have appeared in the American Economic Review, Econometrica, Journal of Political Economy, and other leading professional journals.
His books have been translated into 23 languages, including Choosing the Right Pond, Passions Within Reason, Microeconomics and Behavior, Principles of Economics (with Ben Bernanke), Luxury Fever, What Price the Moral High Ground?, Falling Behind, The Economic Naturalist, The Darwin Economy, and Success and Luck.
The world is a highly competitive place, and becoming successful requires hard work, dedication, and luck. This is the view of today’s guest, Professor Robert Frank, who helps us unravel the nuance of conspicuous consumption trends and the role of luck in gaining financial success. Professor Frank is the emeritus Henrietta Johnson Louis Professor of Management at Cornell University and holds an MA in statistics and a Ph.D. in Economics from UC Berkeley. He is also a prolific author, having written 12 books, financial textbooks, and many peer-reviewed articles in journals such as the American Economic Review, Econometrica, and Journal of Political Economy. He is passionate about how policy can help drive positive consumer behaviour, reduce inequality, and increase individual happiness. His work has also focused on the role of luck in achieving financial success which he covers in his book Success and Luck. In this episode, we unpack how individuals can improve societal collective action, the role of policy in driving those changes, and how luck interplays with success. We discuss economic and financial relativism, the dangers of conspicuous consumption, how expenditure cascades occur, and what influences consumption trends in society. We also dive into the topic of luck, whether wealthy people are happier, what behavioural changes are needed to create a better society, and more.
Key Points From This Episode:
Professor Frank describes the difference between departures from rational choice with regret and without regret. (0:04:34)
Whether he classifies his work as behavioural economics. (0:07:38)
An explanation of economic and financial relativism. (0:10:50)
The role of economic and financial relativism in consumption trends. (0:12:44)
Find out what constitutes a positional good. (0:16:56)
How the consumption of positional goods affects psychological well-being. (0:19:32)
Why people choose to engage in consumption arms races. (0:21:52)
The relationship between the consumption of luxury goods and happiness. (0:24:45)
What people can do to recognize and avoid negative consumption behaviours. (0:26:31)
How the spending of the super-rich impacts the spending habits of the typical consumer. (0:27:38)
Ways in which social media influencers have affected consumption. (0:30:32)
We learn about the link between consumption and inequality. (0:32:40)
How well differences in human capital explain differences in income. (0:35:04)
Professor Frank explains how likely it is that the most skilled person gets the best outcome in a competitive market. (0:38:13)
Professor Frank shares how they measure luck. (0:41:20)
The influence luck has on achieving a successful outcome. (0:42:09)
Find out if luck influences consumption trends and inequality. (0:44:03)
A thought experiment concerning the wealthy and higher taxes. (0:46:56)
We discuss whether winner-take-all markets are a good thing for society. (0:50:22)
How people should behave differently to help drive positive change. (0:53:06)
Advice for people to stay motivated and work hard. (0:57:19)
What Professor Frank thinks about working a job you hate for more money. (0:58:59)
He provides insight for people who work jobs they hate. (0:59:59)
His approach on the subject of luck and meritocracy with young kids. (1:00:47)
We discuss the idolization of financially successful people. (1:03:36)
How successful individuals should behave differently in an economy where luck plays such an important role. (1:05:38)
The response of successful people to Success and Luck. (1:08:15)
Steps people can take to positively affect those around them. (1:09:29)
Discover what Professor Frank’s position is on policy. (1:14:20)
We hear how Professor Frank defines success in his life. (1:18:33)
Read The Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.
Cameron Passmore: Welcome to Episode 230. This week, we welcome Professor Robert Frank. The best way I can summarize this, Ben, is that this episode will really make you think. His book, Success and Luck was, first of all, highly enjoyable. I love the book. That's what we talked about with him. Boy, does he ever make you think. He goes through all sorts of areas, like the role of luck in your own success, the role of luck in winner take all situation in many businesses. Then he talked about at the end of the podcast, what public policies can be done for the greater good out of things like that.
Ben Felix: Yup. I think, we definitely talked about success and luck and that's why I wanted to speak with Professor Frank. I think, we ended up talking to him about the many topics that he's covered in a bunch of his books. That's what I was going for with the conversation, because it all fits together. I think throughout the conversation, you start to see how it all fits together. One of the big concepts that – well, he didn't like what we called it. We called it relativism. He corrects us in the conversation.
I think it's a good way to describe it, which is that – it's like the whole conspicuous consumption thing, where everybody wants to have more stuff. If people around you have more stuff, like a bigger house, or a nicer car, whatever, then you want that. If everybody's always competing to get the nicest stuff, it turns into this big, messy arms race that's not good for anyone. A lot of his work is on how to combat situations like that. He's taken a bunch of different perspectives to try and accomplish that.
We did talk about policy. That's one of the things that he's very passionate about. We also talked on a bunch of different levels about how individuals can improve the various societal collective action, I guess, problems that we talk about in the episode.
Cameron Passmore: This goes back to your paper on happiness and fulfillment. When you're aware of what makes people happy, maybe there's public policy you could entertain that would help the greater good, the greater level of happiness.
Ben Felix: Yeah. I mean, his policy thing is that if people pay more tax at the higher end, so he advocates for a consumption tax. If people who are spending the most money paid more tax, it decreases the amount of consumption at the extreme end. But relatively, people at the highest end of consumption are still, they're able to buy that much more stuff than people with less money and they’re wealthier just competing for stuff that's less expensive at that point, if everyone's paying more tax. The argument is that nobody is worse off in that case, because one of the things that we talk about is the consumption cascade, I think, he called it, or spending cascade, something like that, where when people at the highest end spend a lot of money, people in the middle who may not have been seeing their incomes rise as much, they try to chase that same type of lifestyle. That causes big problems for everybody.
Cameron Passmore: This links back to luck, because – and he talked about this at length. Luck plays a big part of many people's outcomes. That's the linkage there. Professor Frank is the Henrietta Johnson Louis Professor of Management emeritus at Cornell. He has an MA in statistics and a Ph.D. in Economics from UC Berkeley. His papers have appeared in the American Economic Review, Econometrica, and also, the Journal of Political Economy.
Ben Felix: He's written a ton of books, like Success and Luck that we mentioned. He's written, I counted 12 books like that. I guess, more of a popular book that a non-economist would read, but from the perspective of an economist. We got one on luxury goods called Luxury Fever, and a bunch of other very interesting books like that. He also co-authored an economics textbook, Principles of Economics with Ben Bernanke, which is pretty cool. He was a Peace Corps volunteer in Nepal, earlier in his life, and he talks about it in his book, Success and Luck. He talks about how much that experience informed his thinking on economics.
Cameron Passmore: Anything else, Ben?
Ben Felix: No, I think that's enough for an introduction. It's a very interesting conversation. It's heavy at times, because it's – I mean, it’s a lot. It's a lot of stuff to think through and process and it's through and through a different perspective on how to view the world.
Cameron Passmore: Let's jump to our conversation with Professor Robert Frank.
***
Professor Robert Frank, welcome to the Rational Reminder Podcast.
Thanks, Ben. Nice to be with you.
How do you describe the difference between departures from rational choice with regret and without regret?
I always was a little regretful about having used that terminology because it seems to lead to fruitless debates about what it means to be rational. But let me just say what I meant by it when I was writing about that. Rationality means being efficient in the pursuit of your ends. An individual can be rational if what she does serves her ends in an efficient way. There are also many cases where each individual can act in a rational way. Yet, the end result is something that none of us likes.
A simple example is, everybody stands up to see better, nobody sees any better than if everybody had remained comfortably seated. I would say that you don't have any reason to feel regret that you stood up. If you hadn't stood up, you wouldn't see it all. There's no regret on your part. Yet, if we had some means to enforce an agreement that none of us stand up, we would sign on to that. It's often not convenient to do that, so we just live with the outcome. In cases where the losses are much bigger than the mere discomfort from having to stand when you don't need to, we do take steps to limit ourselves from standing up to no purpose. That's a departure from rational choice without regret.
The more common departure from rational choice that's been discussed by economists in the last 30 years has been in the context of the behavioural economics movement, where the theme has been people aren't nearly as smart as the economists assume. We economists say, rational people will ignore sunk costs when they're making decisions about what to do. A sunk cost is one that you can't get back at the moment you decide about something.
Here you have two people, in one of the famous examples, both of them are going to a concert 60 miles away. One of them bought his ticket for a $100. The other one won it in a radio raffle. Now, a few hours before the concert starts, we have a unexpected heavy snowstorm start, who's more likely to go to the concert? The person who bought their ticket, or the person who won it on a raffle? Well, the rational choice model says, they should be equally likely to go. The cost of the ticket is a sunk cost in the case of the guy who paid cash for it. Yet, what we know from experiments and plain observation is that the person who bought the ticket is much more likely to drive through the snowstorm.
That's irrational. If the cost of driving through the storm outweighs the enjoyment you expect to get from the concert, which is what the winner of the ticket seems to think, then you shouldn't go. When people understand the point embedded in examples like that, they seem to feel motivated to change their behaviour. They want to ignore sunk costs in the future. That's what I call departures from rational choice with regret.
I do like those definitions. I know, you said you regret framing it that way. I think that's a great explanation. Do you consider your work, or yourself to be behavioural economics?
I used to wrestle with that question. The behavioural economics movement was born at Cornell, my home institution. The father of the movement, I think by consensus is Richard Thaler, my former colleague. His work focused almost exclusively on what I'm calling departures from rational choice with regret. People just making stupid mistakes. He had worked with Amos Tversky and Danny Kahneman. Tversky, we had been at Stanford. He liked to say, “My colleagues, they study artificial intelligence. Me, I study natural stupidity.” He was very excited whenever he could find another example, where people who had all the information they needed to reach the right answer, nonetheless, got it wrong.
The behavioural economics movement mainly stressed people getting it wrong. I feel comfortable with people getting it wrong a lot of the time. I think that's descriptive. My own interest was always in what I've called departures from rational choice without regret, where you don't feel like you've gotten it wrong, because you haven't gotten it wrong. It's just that the structure of the problem you're trying to solve means that what's in your individual interest to do generates a bad outcome for everybody. That's just at the heart of the public policy dilemmas we face all throughout the world.
The climate crisis is rooted in that simple insight. Virtually, every major problem we face comes from that. I didn't know whether to call myself a behavioural economist or not. I've recently tilted in favour of calling myself one. That's only because of the question that I've always found hard to answer, if people should vote for the policies I recommend, because that would make them healthier and happier and wouldn't involve giving up anything they really care about, why don't they vote for them? Instead, they vote for these people who don't enact these policies. That for me is a very tough question. If I'm so smart, how come I'm not rich?
I finally began to see that the reason people don't vote for policymakers who champion those policies, is they think the higher tax is necessary to underwrite them, will make them unhappy. That's a cognitive error. That's a departure from rational choice with regret. I think if I pay more in taxes, I won't be able to buy the special extras I really want. What that overlooks is that if I'm a wealthy taxpayer, and I'm paying more in taxes, so are my peers, and the luxuries that we all want are in short supply, that's what really makes us think of them as luxuries. If my purchasing power goes down because of an increase in the taxes I paid, to pay for bike lanes and other public goods, so do your taxes go up and your purchasing power go down, our relative betting power is exactly the same as before. The same marvellous penthouse apartments overlooking Lake Ontario go to the same buyers as before. I’m a behavioural economist. Yes.
That's a perfect setup to our next question, which is, what are economic and financial relativism?
I'm not sure I would choose relativism as the first term to describe what you have in mind, although I certainly get where that term would have currency. I think, if you talk about relativism, that's linked to what people associate with feelings of envy and jealousy, negative emotions. People acknowledge that other people have those feelings. Most people would feel they don't suffer from negative emotions like that. I think, I'm much more comfortable talking about the link between context and evaluation. Everybody feels comfortable acknowledging that. Is it cold out? You're on the Celsius scale in Toronto. It's 16 degrees. Is it cold out? Well, if you ask somebody where I grew up, I grew up in Miami, Florida. Is it cold out? It's a November evening. We knew the answer. It's freezing out. We would wear the heaviest coats we had if we were going to a football game.
If they asked you that question on a nice, sunny day in March. Is it cold out in Toronto? You'll know the answer to but it'll be the exact opposite answer. Of course, it's not cold. Look at everybody out there celebrating the nice day in their shirtsleeves. Yeah, context matters. It shapes our evaluations, we're normal, we like nice things. Sometimes bigger seems nice, so we like bigger more often than not. We like faster more often than not. We like louder more often than not. Yet, all those things in order to seem big, or fast, or loud, it has to be big, or fast, or loud relative to some appropriately chosen frame of reference. That's the basic truth that I think no thoughtful person would think to question. You don't have to argue about whether people are feeling envious or not, even on a desert island where you're the only person. If you had a bigger house, that would feel good to you.
What role has that effect played in consumption trends?
You have to look to the changes in the distribution of income to see how that's evolved. We were in an unusual historical period during the three decades right after World War II. Incomes during those decades were growing at about the same rate for everybody. People at the bottom were actually seeing their incomes grow slightly faster than everyone else's. Mainly, it was all incomes rising at about the same rate.
Suddenly, late 60s, early 70s, that all changed. Virtually, all the income gains in the years since then have gone to people at the top of the income ladder. That's something I've written about. We can talk about that at some point later. For the moment, just take that as a stylized fact for our discussion. What do people do when they get more money? They spend more. That's not a criticism of it. It's not a moral indictment of the rich that they would spend more because they have more money. That's what the people at the bottom of the ladder do too. People in the middle do that. Of course, the rich do that. They have built bigger.
The effect of that is not to make people in the middle feel angry. No, it's interesting. Some of the most popular programming of those decades was lifestyles of the rich and famous. People wanted to see pictures of the mansions and the Ferraris and the helicopter landing pads. Maybe I'll be rich someday. Maybe that's how I’ll live. There was no sense of injury on the part of people in the middle. Where those bigger mansions had an impact was well, right, let's say a mansion has doubled in size, then their daughter gets married, they invite their friends to the wedding reception. Everybody comes and sees it.
Now, the wedding reception is held in the home of the bride's family, not in a country club, or a hotel. There's a ballroom big enough to accommodate 200 guests and an orchestra. We need to build bigger. A group goes home, they build bigger. Then they've got a group of friends that – these social circles are largely segregated, but not completely. They've got a group of friends maybe just a little bit less rich than themselves. They come for dinner and they leave thinking, we need a dining room to be able to seat 18, 12 is not enough. That's now the norm.
It cascades all the way down the income ladder. I think, if you don't make reference to that kind of income effect on what I've called an expenditure cascade, you can't really explain why the house in the middle has grown 50% in terms of his footprint. The people in the middle don't have more real income. They have a slight increase over what they had 40 years ago in real terms, but only because they're more two earner couples. Where did the second income go? It went into a bidding war for houses in better school districts.
You could tell the people in the middle, you can't afford this big house you've bought, or this expensive house you bought. Be prudent. Buy only what you can afford. Well, that's fine. That's in general, good advice. Except for one thing, in the case of housing, everywhere in the world, access to better schools depends on having access to more expensive housing. The good schools are always in everywhere, the ones that serve the more expensive neighbourhoods.
If you're in the middle, you’re a parent in the middle, you’re the middle earner, if you don't buy at least the median price house for your area, it's your kids who will go to the schools that have reading scores in the 20th percentile. That's a bad choice. You can either break your budget, not add to your retirement savings, take out bigger loans than you can afford to repay, or you can send your kids to the bad schools. Which do you want to do? Most parents say, well, I'll worry about retirement when the time comes. I'm getting my kid into the best school I can. They work every margin they can to keep up. That's been a fruitless arms race. When everybody bids more and more for housing, the better school districts, all they succeed in doing is bidding up the prices of those houses.
Half of all kids still go to bottom half schools, same as before. That's again, the link between context and evaluation. Is it a good school? What does that mean it's a good school? It's a school that compares favourable to other schools in the area.
What constitutes a positional good?
This is a term I borrowed from the late British economist, Fred Hirsch. He called positional goods, ones that are in scarce supply inherently. He might have been talking about beachfront property, or rooftop condominiums, penthouse with a sweeping view. There are only a limited number of such things. They're positional goods. You have to bid for them. I have a more general concept in mind. They are things whose value depends more heavily on context than other things that I call non-positional goods. What are non-positional goods? Goods whose value doesn't depend so much on context.
If you give people a choice between two worlds, you can live in world A, where you have a two in 100 chance of dying on the job this year, let's focus on workplace safety. You have a two in 100,000 chance of dying on the job this year, everyone else has a one in 100,000 chance of dying on a job. Your job is relatively risky. You can live there, or you can emigrate to another planet where you have a four in 100,000 chance of dying on the job. Twice as risky as the one you have now, or, and everyone else there has a six in 100,000 chance of dying on a job.
Even though the new planet has a riskier job for you, everyone else's job is even more risky than yours. You have a relatively safe job there. Which do you choose? If you give people that choice, I've never yet in a group seen one person who chooses to move to the planet where the risk is four in a 100,000 for him, and six in a 100,000 for everyone else. Everybody chooses absolute safety over relative safety. If you do that same experiment with a relatively big house versus an absolutely big house, but relatively small house, people always choose the relatively big house. That's what I would choose. I would want my kids to go to good school. The world, we're at a relatively big house would be more likely to satisfy that demand.
Positional goods, they're ones that depend on context. Everything depends on context. Non-positional goods, they're just goods that don't depend that much on context. Public goods, those are the quintessential non-positional goods because they're the same for everyone.
How does the consumption of positional goods, like when we're talking about the house arms race, or the house size arms race, how does that pursuit affect psychological well-being?
You're familiar. Everyone's familiar with the military arms race narrative. Rival nations get involved in competitions where they build more and more armaments. The driving force behind those armaments, expenditure arms races, is the fear of falling behind your rival nations. If you have fewer arms than they do, your political independence is at risk. Now, people don't like to have fewer hospitals, fewer schools, less well-paved roads, fewer fast trains in other nations. Having less of those things is unpleasant, but it's not existential. Having fewer bombs than they have is a much bigger threat than having fewer of other goods.
It's only because of that, that we see this dynamic where resources get sucked out of other goods. We spend less on hospitals and schools and roads and television sets and toasters in order to fund expenditures on armaments, to no good effect. Because when we all spend more on arms, nobody's more secure than before, that's completely uncontroversial. We routinely, when we can engage in arms control agreements, pledges that we sign subject to enforcement and inspection, where we won’t build bombs, if you don't build bombs. That will free up for both sides more resources for these other things that we all agree it would be better if we all had more of them. We don't think it would be better if we all had more bombs, but we do think it would be better if we all had more bike lanes and more of these other things.
That's the narrative. Positional goods are to non-positional goods, as bombs are to toasters. If you don't like the military arms race narrative, then you won't like my policy prescription. What's the problem you have the military arms race narrative? That would be my question. You don't think that's a valid description of events in the world? If you agree that it is, then what's the logical fallacy in arguing that we spend too much on positional goods and not enough on non-positional goods? In fact, we can point to a whole host of public policies whose most cogent interpretation is to steer resources away from positional goods toward non-positional goods.
If we go back to consumption for a second, why do people engage in consumption arms races?
Again, this is just a simple example of what makes sense for the individual to do versus what makes sense for us all to do. It makes sense for us individually to stand up to see better. It doesn't make sense for us all to stand up to see better. We should, if we could implement an agreement, whereby we all accept sitting down to see the performance we're hoping to see.
I have no criticism of people who find pleasure in spending their money on nice things. That's a totally human impulse. What's worrisome is that when there is clear evidence that mutual restraint to channel those same resources into other uses would produce better outcomes for virtually everyone without requiring any sense of painful sacrifice from anyone, why resist that? People say, “Oh, well, that robs us of our freedom to decide how to spend our money as we choose.”
Well, yes, it does. Think of other steps we take. Tom Schilling, one of my economic heroes asked, “Why do hockey players always skate without helmets, unless there's a rule requiring them to wear them? If helmets are so great, why do you need a rule? Why don't you just wear them?” The answer, according to his analysis was quite simple. If you take your helmet off, you gain an individual edge for your team. You can see better, you can hear better. Maybe you can intimidate the rival team players more effectively because they see that you're crazy enough to risk injury by skating without one. You gain an edge. That's something that every athlete values far more in the moment than the risk that he might get hurt. Probably won't get hurt.
If he gets hurt, that's some time on in the future. It's individually a compelling choice to take your helmet off. The best response from the other side is to match that. They take their helmets off too, and then the equilibrium is everybody skates without helmets. Everybody has a greater risk of injury and death. Nobody's more likely to win the game than before. Yes, a hockey helmet rule deprives the individual hockey player of his freedom to skate without a helmet. But to object to that on the grounds that it robs him of his freedom, his freedom was what he wanted to forego in order to get the rule he wanted.
That would be objecting to a military arms control agreement on the grounds that it robs the individual nations of the freedom to build as many bombs as they want to. That's what it does, but that's the whole point. That's what they want it to do. The language of freedom has been utterly corrupted in public policy debate. It's a much more interesting and nuanced concept than the simple slogans acknowledge.
Can you touch a little bit more on – and this is something that we've talked about on our podcast extensively, just the relationship between consumption of luxury goods and happiness?
When you buy a bigger TV, or a nicer refrigerator, you're happy about that. If everyone has a flat screen TV with 4K resolution, then you do quickly adapt to that. Am I happier watching? As it happens, I have a seven, or eight-year-old plasma TV, which seemed really exciting when I first got it. I can't honestly testify that I'm happier now. Because maybe if I go visit a friend who has an 8K TV, then my TV will seem blurry. I'll need a new one. Those things, the link between them and once you've adapted and once everybody else has them, the link between them and psychological well-being is tenuous at best. In most cases, not even measurable.
The link between many other kinds of expenditure and happiness and well-being is easily demonstrated. My colleague, Tom Gilovich, has done some very compelling work showing that money spent on experiences has a far more profound and enduring effect on psychological well-being, than money spent on goods. People are less likely to have context in which they compare experiences unfavourably with the experiences of others. It's just the psychology we've inherited, has some asymmetries in it that make us as individuals, choose expenditure patterns that don't add up to a very good outcome for us collectively.
Yup. Yeah, we've talked about a lot of Tom’s papers, that's fantastic work. You've mentioned a couple of – well, we haven't gotten into it at all, but you've mentioned policy a few times. If we step back from that, what do you think individuals can do to recognize these patterns and maybe avoid them?
A lot of this is local. If you don't want your kids to feel like material things are the be all and end all, there are some cultures that celebrate material acquisition – local cultures, I'm talking about, that celebrate acquisition much more than others. I think, that would be one of the things to factor into the mix of a decision about where to live, who to choose, as friends. If you want to be more of a climate advocate, then choosing a peer group that has similar aspirations will make it seem more comfortable with the consumption standard that's consistent with climate advocacy.
If most of your friends are jetting off to destinations two or three times a month and you're not, then you'll feel deprived. If you hang out with bicyclists and hikers who vacation on old railroad trails closer to home, you're not going to be less happy but you'll be better able to live whatever you feel your ideals call for.
You talked about housing. But more generally, how does the spending of the super-rich impact the spending habits of the typical consumer?
Again, it's very seldom that we see any direct link between what somebody in the middle buys, and what somebody at the top buys. The people at the top can afford things that aren't even in the dream of set for the people in the middle. That doesn't mean that they're not linked. I think a nice example is the size of the vehicles people buy. There never were vehicles in consumer garages that weigh a 1,000 pounds when I was growing up. There was no such thing as a vehicle that big.
Yet, I remember, there was a Robert Altman film in which Tim Robbins was a Hollywood player, and he had a Range Rover SUV. I'd never heard of an SUV before. This one had a fax machine on the dashboard. It was equipped in a way that people in 1970s had never seen before. All of a sudden, the SUV became a symbol of consumer prosperity. What's true is that if everybody is driving 2,000-pound cars in the initial state of the world, and then somebody buys an 8,000-pound car, that person is going to be at much less risk of injury and death than everyone else.
If he gets run into by a 2,000-pound car, he might not even notice. It'll bounce off of him and roll into a ditch. It may be the best response of the individual motorists who are driving 2,000-pound cars to buy an 8,000-pound vehicle themselves. That may be their best response as it's the best response for somebody to stand up, if somebody in front is standing up in front of him. When everybody's driving an 8,000-pound car, everybody's risk of injury and death is higher than if everybody were driving a 2,000-pound car.
If all you care about is safety, your individual incentives and your collective incentives are pointing in exactly 180 degrees opposite directions. You can't get what you want. When I say you as a society, you can't get what you want by saying, individuals, go buy what you feel like. Now, we could adapt a ham-fisted response to that, was it, all vehicles over 4,000 pounds are against the law. Some people have legitimate interests in driving bigger vehicles. Maybe they have a cottage in northern Ontario, they have to tow their boat up there on the weekends and a small car just won’t do it. All right, you can buy a heavier vehicle. We’ll tax vehicles by weight. Yes, you're going to impose harm on others and on the planet by belching more fumes into the air, but you'll compensate for that by paying an extra tax on the extra weight of the vehicle they bought. There's all sorts of ways to realign the interests of individuals and groups, short of adopting a bullying approach where we tell people, they just can't do what they want to do.
Interesting. How do you think social media, or perhaps influencers have affected consumption?
Yeah. I think, the visibility of what others are doing has always been a factor in individual behaviour. That's not a bad thing, per se. I mean, it's a complicated, uncertain world out there. If we didn't take our cues about what to do from watching other people, we'd be hopelessly at sea, really. Yeah, it's a generally sound impulse to be influenced by what other others do. Those influences aren't always for the better. If you're worried that your daughter is going to be a smoker, forget about the price of cigarettes, or how much allowance she gets, the overwhelmingly most powerful predictor of what she'll do is, the proportion of her friends who smoke. If that number goes up by a certain fraction, there's no bigger influence on the likelihood that she'll become, or remain a smoker every year.
Yeah, we're influenced by what others do, and not always for the better. If we take into account the effects we have on others, we taxed cigarettes starting in the 1980s in the US. I don't know what the timetable was. We didn't do it until there were studies coming out of Japan showing that exposure to secondhand smoke caused harm to others. That was our rationale. Actually, exposure to secondhand smoke, if you don't work in a crowded bar with no ventilation eight hours a day, that's a very minor hazard to your health. It's measurable, it's real, but it's very small.
The real harm you do if you're a smoker is not to breathe smoke on them. That is a harm, but it's a very minor harm. The real harm you do is to make other people more likely to smoke. Taxing cigarettes is a perfectly rational and legitimate response as a way of trying to take that disjuncture between your individual incentive to smoke. I'll smoke, because I feel like smoking. Our collective incentives for you to smoke, if everybody smokes, then my kids are more likely to smoke.
What does the evidence say about the relationship between this consumption arms race that we've been talking about and inequality?
It's driven by inequality. I mean, even when we had inequality of the 1960 level, there was some inequality. The expenditures of the people at the top cascaded down the income ladder then as they do now. What's different is that now it's a dynamic process and it's getting worse. The people at the top are getting the lion's share of the income growth each year, and so their spending is having a bigger effect each year on people below them. It's always been a cascade.
Back when Galbraith was writing, he talked about the glut of private goods, Galbraith, the best Canadian economists of the 20th century, the glut of private goods and the shortage of decent public expenditure, filthy public squares, power lines that should have buried decades early. All that that he wrote about was just an example of heavy spending on private positional goods, insufficient spending on public non-positional goods.
I was once asked to write a column about why Galbraith never won the prize, the Nobel Prize. He was an incredibly influential economist. I think the reason was that even though he was right about that big issue, he was right for the wrong reason. He said, “We don't spend enough on public goods because corporations bamboozle consumers into buying whatever junk they want to put in front of them.” I think that gives consumers short shrift. The Ford Motor Company tried its best. It's spent at the time, the very largest sum ever expended on an advertising campaign. They could not persuade the American public to buy the Edsel motorcar.
The people spend too much on those goods because others spend too much on those goods. Why do they spend more? Because people at the top spend more. It's just all a matter of wanting to have something that seems nice. To seem nice, it has to seem nice relative to other things.
You can see, all the concepts from your books, you can see how they all line up. There's the influence that we're talking about, there's the relative consumption and the chasing of luxury goods. I want to pivot a little bit toward your work on luck and meritocracy. We're talking about inequality. We're talking about people at the top of the income distribution influencing everybody else and exacerbating these problems. How well do differences in human capital explain those differences in incomes across the distribution?
Yeah, that's a good question. That's the primary economic model of earnings differences. Why do some people earn more than others? It's because they have more human capital, which is an amalgam of traits. It's your age, your education, your experience, your intelligence, your social skills, in some occupations skills like strength and speed matter. It's a whole laundry list of things. It's true that people who have – we can measure the extent to which traits like that influence earnings, and they do. There's a whole literature on that. The people who have more of the relevant traits do earn more.
There's no question but that there's a model that has purchase in reality there. What's also true, though, is that the distribution of incomes has become vastly more unequal in the last four decades. The distribution of human capital has not changed in any appreciable way. I think if you want to argue that it's human capital that explains the growing income gap, you really don't have any persuasive data to rest your case on.
What's happened is that, and this is the thesis of my work with Philip Cook, an economist at Duke in our 1995 book titled The Winner Take All Society. We argued that rising inequality was due primarily to changes in technology that enable the people who are the best at what they do, to extend their reach further and further. If you're once the best practitioner in southern Ontario, you were a player in that market than it was you are a player in the whole eastern Canadian market. Then finally, you can serve the whole world market. If you’re really the best of what you do, it's ideas that are the most valuable components of any product. You can ship ideas anywhere for free. They don't weigh anything.
What the technology has done has been to greatly empower the people who are naturally the best at what they do, even if they're only slightly better. We saw in the case of musicians, there was in the early 1900s a risk market for thousands of sopranos around the world. Everybody wanted to hear the best, but the best couldn't be everywhere at once. There were only so many venues the best performer could get to. Now, when most of the music we listen to is in recorded form, we don't really need thousands of sopranos, or tenors anymore. It was just a handful conserve the lion's share, or at least the most valuable slice of that market.
They get seven-figure, eight-figure contracts, while people who are almost as good end up teaching music lessons in Vermont to third graders. It's not that the people at the top who are earning the most are that much better. It's that the technology amplifies the small differences into huge differences in pay.
Fascinating. How likely is the most talented, or skilled person to get the best outcome in what we find here, a highly competitive market?
If you do get to be the best at what you do, and it's something that lots of people value all around the world, that's an enormous prize. If you're the best novelist, if you're the best sprinter, if you're the best home-run hitter, if you're the best goal scorer, that's a huge prize. Naturally, there are strong incentives for people to compete for it. If you have any of these big tournaments, where the winners are selected, there are literally hundreds of thousands of contestants.
If you ask how many young kids in the United States want to be shortstop for the New York Yankees, I would be astonished to learn that the number was less than a million. It's a win-win process. They get cut at every stage, but still a very large number by the time you get up to the final rounds. There are natural limits on how good someone can be. There's only so many hours in the day you can work. There's only so many IQ points we've ever observed in human being. There's only so much talent can be housed in an individual.
If you look at an arena where it's mostly meritocratic. Everybody agrees, it's the fastest runner who wins. Even in arenas like that, a group of European physicists and I published a paper last year talking about the role of luck in the 100-meter competition. The role of luck is very small in that competition, but it's on the order of a couple of percent. Suppose the role of luck amounts to nothing. That is to say very, very little, then you've got scores, hundreds, thousands of people clustered near these upper limits on talent and effort. They're all working as hard as they can. They're all as talented as they can possibly be. Find that most talented, hardest working person in that group. Let's call him am Mr. X. Is he lucky or not? Let's say, luck doesn't matter much. It counts for 2% or 1% for total performance. Is he lucky or not?
Well, we chose him because he was the most talented and hard-working. He might be lucky, he might be unlucky. On average, he'll have average luck. There's going to be not one, not two, but a whole bunch of people breathing down his neck in terms of their talent, plus effort values. Some of them will be unlucky. Some of them will have average luck, but there'll be at least some in that group that were really lucky. Let luck count for only 1%. That's all it takes for luck to have pushed that person ahead of the guy who was most talented and hardworking. Does talent and hard work matter? Yes. I think, people have misunderstood me to be saying that those things don't matter. Of course, they matter. These are very competitive markets.
Luck matters, too. In fact, luck is essential. I think, for the winner to realize that, but for luck, she wouldn't be there is a very healthy realization for the winner to have. This fiction that it's all my doing. I'm entitled to every nickel that came my way, is one of the most damaging points of view that people who are in the winner's circle can take to the public arena.
How did you measure luck in that paper with the runners?
Yeah, that was complicated. It was a question of looking at some win scores, and looking at natural variation in their own scores. They have good days and bad days. Yeah, these were much smarter people than I am, who were my co-authors on that paper. You have to have them on, if you really want to know how they did it, but it looked right to me what they did.
You've co-authored papers with some fascinating people, like Tom Gilovich, Ben Bernanke with the textbook and the physicist that you just mentioned, that's fascinating.
Yeah. That's good luck, to have been able to collaborate with people who can do things so much better than you can.
Yeah, super interesting. From the example you just gave from that paper, it's like, even if luck makes a small contribution to outcomes, it can explain a large portion of the difference in outcomes between the highest performers. Is that –
Yeah. For luck, that winner wouldn't have won. Somebody else would have won, who would have been, essentially, just a whisker less good. I don't mean to be harsh for the people who say, “I did it all myself.” If you succeed in one of these competitive arenas, it's true, you did work hard. You came in early all those days. You stayed late. You had to vanquish people who were really good. You solved a lot of really difficult problems. To look back on your path and say, “I did it.” That's a totally cogent interpretation of the data. But you shouldn't overlook the fact that there are all these others, people who did it too, why didn't they win? They weren't as lucky as I was.
Yeah. I think in your book, in the appendix of your book, I think it even – you do simulations and find that it's actually fairly unlikely for the most talented, or deserving whatever person to get the best outcome.
Yeah. Those are just hypothetical simulations, but they capture the point we're talking about. Performance depends on talent. It depends on effort in equal measure in the examples we use, and on luck. On luck, only very slightly. In those simulations, whoever has the highest score wins, and in almost a vanishingly small proportion of cases, was it the person with the highest talent and effort score who actually won. Almost always, that individual was edged out by somebody who had almost as high talent and effort scores and was luckier.
Yeah, that's the key is that they were still talented and they still exerted effort.
No, I'm not saying that these people who won, “Oh, they just lucked out.” No, that's not the point. They worked hard. They were good, but they were also lucky.
Yeah, okay. How does this, what we're talking about now, that that role of luck, or the perception of meritocracy maybe, how does that interact with the other things we've talked about, like the consumption trends and inequality?
I think, what's been true in the United States, less in Canada, but it's been true in most of the developed world. You wouldn't want to feel that you're not vulnerable to this influence. What's been true is that as incomes have concentrated at the top, the recipients of those high incomes have adopted it as their cause to lobby the political system to reduce their tax rates. They've been very successful at doing that over the decades, the tax rates.
When I was graduating from college from Georgia Tech in 1966, the tax rate was 70% on the highest earners. It was 92% in World War II, so it had already fallen significantly. It fell as low as 28%. It's now in the mid-30s here, and the Republican Party is trying to reduce it further. The tax rate is where we get the revenue to spend on the things we don't have enough of. We don't have enough investments in the electric grid to make it renewable. We don't have enough bike lanes to wean ourselves off of cars. We don't have enough, in general, in the public sphere, I don't think it's a good idea just to print money and buy those things. We ought to pay for them.
The people who could pay for them, the people who are the winners in the high stakes markets, those are the people with the real resources, they could pay for them, and still have the same relative purchasing power as before. Still buying the same penthouse apartments with the good views as before. Really, no skin off their nose to cooperate here. They're the people who are standing in the way of these policies. It's through their influence on the political system to have lower taxes on them, rather than the taxes we would need in order to pay for the public goods that would benefit not just you and me, but them, them too. They’re driving their Ferraris on the same pothole ridden roads we do.
Can you talk about that example from that you have in the book of the, would you rather have the Porsche on the nice road, or the Ferrari in the –
It’s just a thought experiment. I think, thought experiments are actually useful. I went to a philosopher’s talk when I was just starting out as a professor at Cornell. He used a couple of thought experiments to launch his talk. It really put me in the mood for the points he was trying to make in his talk. I later read about it and said, the brain absorbs information more efficiently if blood is already flowing to the part of the brain that's good at processing. When you think about a thought experiment in the domain of the subject that the speaker wants to call attention to, you can actually understand the argument better. Yeah, the thought experiments. What is the issue that you'd like Illuminated? I've gotten a lot of thought experiments. What's the specific thing you're curious about?
I think that the example that you give in the book is useful. Just in thinking about the tradeoff that you're talking about, where if the roads are terrible, wealthy people might not be so happy in their very expensive cars.
Okay, so I'll use that one. Imagine that there are two worlds, a high-tax world and a low-tax world. In the high-tax world, wealthy drivers have less money to spend on cars. Of course. No need to argue about that. Let's imagine that in the low-tax world, which I imagine being the US, the wealthy drivers with low tax rates buy the Ferrari Berlinetta. It's cost a third of a million dollars. It's a fabulous car by anyone's reckoning.
The people in the high-tax world don't have that much money. They are forced to make do with the lowly, Porsche 911 Turbo. It's retailing for roughly $150,000. Now, in fact, there's not much difference in the absolute quality levels of those two cars, if only because by the time you get up to the Porsche 911 Turbo, that's a car that has virtually every design feature that has any measurable impact on handling and performance already incorporated into it.
Just for the argument's sake, I suppose the Ferrari is better. The point is, if it is better, it's not much better, it's only slightly better. Then the question is, we've got the two worlds. High tax, low tax. Ferrari drivers in the low-tax world. Porsche drivers in the high tax. Who's happier? The Ferrari drivers, or the Porsche drivers? Everything else is the same in the two worlds, suppose initially. That is a question that we can't answer according to any real data that has been studied.
What we know is that the most defensible answer is that they'll be equally happy. Why? Because there's really not much difference in measurable performance that we can detect between the two cars. In each case, the main thing that we know matters, the drivers of their cars will have good reason to believe they're driving the best cars available. The Porsche in one case and the Ferrari in the other case. Okay, so they're equally happy. That immediately ought to be a clue that something's inefficient because the Ferrari drives are spending three times as much, but more than two times as much. The two worlds won't be the same in all of the respects. Here, I'll invite people to adapt the most critical view of government waste they can. The government exists primarily for the purpose of crowning welfare queens and building bridges to nowhere. They've wasted money with such gusto that it's hard to find anything useful that they do.
Okay. Well, then you look at government budgets. You say that most of the expenditures are on medical care, retirement payments, defence, and other things that most voters seem to want to keep in the budget, so it's not all waste. A lot of what they spend is on infrastructure. Then the thought experiment becomes, which would be a happier set of wealthy drivers. The Porsche drivers in the high-tax world driving their Porsches on mirror-smooth highways that are well-maintained with the higher tax revenues, or the Ferrari drivers in the US who are driving their Ferraris on these roads riddled with foot-deep potholes every 10 feet. That's not an interesting question. Does that prove anything? Well, no. Not really. I think if you couldn't remember the gist of the argument that will help summon the logic of it for review later when you'd want to think about it.
Are winner-take-all markets a good thing for society?
Yes, and no. Let's suppose, you have a 10-year-old with a life-threatening illness, and you live in a small northern Ontario town. Would you want to consult with the best local practitioner on what to do about your child's illness? Or, would you rather have the clinic in your town wire the X-rays and the scans and the data to the world's leading expert on this rare disease, who happens to be a practitioner in London? That's not a hard call for me and probably not for you either.
The idea that we can buy from the best producers in every sector more now than in the past, is in general, a good thing. Maybe it's not a huge advantage, as it might be in the case of a life-threatening illness, but it's better to buy from a good producer than one that that does good. That part's good. The downside is that it's made an enormous contribution to growing income and wealth inequality. That has had enormously destructive effects on society, as we've seen.
The sad thing is that we don't have to really choose. We would still have vigorous competition to be in the winner's circle, in those winner-take-all markets. We would still get high-quality producers serving broader markets, even if they had to pay much higher levies on their outsized earnings. We could pay for the public goods that would actually make a difference in people's lives. It's just a shame. How should I feel about this? I tend to get feeling low about the fact that this is a very simple argument. I've done my level best to reduce it to its clearest possible terms, and I've tried to put it in front of as many people as possible. Yet, year in and year out, we don't do anything about it.
When I think about the world that way, I feel like an abject failure. Why couldn't I persuade people to do this simple step that would benefit everybody? I was complaining about that to a friend, old friend who visited this summer. He said, “Well, think about it this way.” I don't know if you have anything like this in Canada, but we have the carried interest loophole here in the United States. Your listeners probably are very familiar with it. There's absolutely no defence of it taxing that income differently from the way we tax other incomes. Everybody agrees that that's true, and yet we can’t eliminate it. So he says, “If you want to feel bad, then adopt your tax.” Think about that.
How do you think individual people, to bring it back to that level again, should behave differently to find individual success in a winner-take-all environment?
Yeah, that's a great question. I'm not going to say that material success doesn't matter. Obviously, it does matter. If you don't have a certain amount of money, you can't keep your kids out of the bad schools, of which there are many, unfortunately. There is pressure to achieve material success. For many years, I've taught MBA students and it's been a challenge to me to persuade them not to assume that the highest paying job offer they receive is the one they ought to accept.
There's an old issue in economics, ever since Adam Smith's day really, that the less pleasant the job is, the more they have to pay you to get you to take it. If the factory is really smelly, in one case, and it's in a pleasant environment in another and everything else is the same, wages will be higher in the smelly factory than in the sweet smelling one, just because nobody wants to work in the smelly – this is not a controversial point.
I say, think about your job offers that way. The amount of money they pay you depends on many things, not just on how good you are, but on how unpleasant most people find the things they want you to do. I personally would find a job in some of the industry positions they take just complete suicide. I would not be able to get out of the bed in the morning if I had a job like that. Many of them temperamentally seem better suited to jobs like that. What we know is true is that everybody cares about the conditions on the job and the jobs that tend to pay better are the ones where they ask you to do something a little bit questionable.
Nobody wants to go home at the end of the day saying, “I really screwed people today.” I shouldn't say nobody, but very few people take any pleasure in that. What I tell students is to try to think of a time when you were really engrossed in a task, where you found the task so rewarding that you didn't want to quit doing it. Then suddenly, the day had expired. You weren't even aware it was the end of the day coming up. Can you think of a time like that? That students will think about it and make as – yeah, it was when I did X or Y.
I said, if you can possibly find a job that has you involved in a task like that, grab it. Never mind what they pay you. Here's the logic that I base that recommendation on. There's a big literature on expertise. The debate is does it take 2,000 hours to become a real expert at something? Or is it 10,000, or maybe even 20,000 hours? We don't know. Maybe it's different in different areas. It's really hard to become an expert. You got to focus for a very long period of time to master the skills that will let you say credibly, “I'm really one of the best people who does this thing.”
If it's a job you don't like, what are the odds you're going to be able to do that? You're never going to be the best at what you do if you're working at a job you don't like. I wouldn’t say never, but it's very unlikely that you will. The way markets are trending, it doesn't matter if half the world wants to buy what you're good at, or a third of the world, or even a 10th, or a 1000th of the world. If a small slice of the world cares about this thing you're good at, it's now so easy to hook up those people with the people who are best at what they're producing that one thing, that you can be a winner in that kind of a market.
If you are wondering, you can make a lot of money, which would be nice, most people think. If you don't end up a big winner, what's the downside? You will have spent your career doing a task that you found utterly absorbing. That's the advice I give.
That's awesome advice. Awesome. We talked to a Canadian astronaut, Chris Hadfield for an episode of this podcast, and he gave the exact same advice. For people who have big dreams, like wanting to be an astronaut or something like that, he basically said exactly what you just said.
Well, clever guy, this astronaut.
Given the pursuit and the 10,000 hours you talk about and given the importance of luck, how should people stay motivated to work hard?
Well, if you're doing a task that you find really engaging, I will make a fool of myself trying to pronounce his name, Mihaly…
Csikszentmihalyi.
Csikszentmihalyi. Okay. He was the person whose work is associated with this concept, the psychologists call flow, where you're so absorbed in what you're doing, you're completely unaware of the passage of time. If you're engaged in a task like that, there's not an issue of keeping motivated. I find working on a book like that. It's very hard to get started on a book. Once I've gotten started, the very first thing I want to do when I get up in the morning is read what I wrote yesterday, then I find things I don't like about it and I start tinkering with it. Then I'm off editing and adding to the chapter I was working on. Then suddenly, it's time for a glass of wine in the evening. I've had that happen. Had the day go by.
If you're engaged in a task like that, it's not an issue of being motivated, you just want to do it. There are a lot of jobs that don't offer much scope for engagement like that. I'm intensely cognizant of the fact that I've been lucky to be able to work in a field that offers opportunities for engagement like that. There are degrees of that available. I mean, you can take pride in all sorts of tasks that you're engaged in, and doesn't have to be something fancy, or technical, or highfalutin.
What do you think about that people, it's become less popular, I think, in the last few years. But for a while, this idea of financial independence, retire early. Work a job that you hate for the least amount of time possible, so that you can be financially independent after that. How does that relate to what you're talking about?
I've known a lot of students who have gone that route. There's an expression many of them use. They call it golden handcuffs. They earn these high salaries, and then they buy a 15,000 square foot house in Greenwich, Connecticut. They've got the Ferrari and the Lamborghini in the garage, and the kids are all going to private schools with tuition of $40,000 a year. I can't afford to retire early and go do what – I've become a prisoner of this lifestyle that I bought my way into. I think that's a risk to be on the lookout for. I don't say, there aren't people who haven't done it. If you feel confident you can do it, who knows? Maybe that's a good step.
What would you say to people who are currently and again, I think that the advice that you gave earlier is phenomenal. Likewise, with what we were just talking about before the financial independence question. What would you say to people who are currently working in a job that they don't find states of flow and that they don't enjoy?
We've seen what has been called the great resignation in the US labour market during the last year and a half, or so. A lot of people are quitting. I think, the kinds of jobs they've been quitting have been jobs that you might describe as ones that offer minimal opportunities for engagement like that. In most cases, they've moved to jobs that didn't quit, not knowing what they were going to do next. They usually quit because they had something better lined up. I think, keep looking. Keep experimenting.
Being willing to move is part of that, if it's not possible to raise your kids in the manner that you think best for them in the current environment, because of external pressures, there are other environments that may offer a different set of constraints.
How would you approach the subject of luck and meritocracy with young kids?
Somebody asked me after my Success and Luck book appeared. Well, if luck is so important, why don't parents tell their kids how important it is? I think that question answers itself. If you imagine the temptations that confront kids growing up, not just kids, human beings, there's a big literature on the temptation of the early reward, hyperbolic discounting, there's a lot of different names for it. Even pigeons, it was studied first in pigeons. A pigeon could peck the red button and get a small reward right away, or wait 15 seconds and peck the green button and get a much, much bigger reward. The pigeons couldn't wait. They pecked the early reward. And so, ha, ha, dumb pigeons. Then they started doing experiments like that with MIT students. The MIT students chose and exactly –
The human nervous system seems to be constituted in such a way that we're very attentive to the immediate costs and benefits we confront, and only vaguely attentive to things that are in the more distant future. Maybe in the environments we evolved in, perhaps conditions were so extremely threatening, that if you didn't focus exclusively on the immediate threats you faced, you were going to get eaten, or killed anyway. That was a pretty good algorithm for allocating your attention. In more secure environments we live in now, that's a recipe for failure. Passing up the small early reward in order to claim the much larger later reward is plain as day the right strategy in so many different decisions that we confront. With this stone age nervous system that we've inherited, it's very hard to execute that.
I would say, if you told kids that you should work as hard as you can, and develop your skills, but remember, you’re not going to win unless you're lucky, many would hear that message differently. They would say, “Oh, I'm not going to win anyway, unless I'm lucky. Maybe I'll just sit back and wait for lightning to strike and I'll win that way.” I would tell kids, “It's all up to you, kid. If you don't make it, you got nobody to blame but yourself, blah, blah, blah.” At the same time, try to make them feel grateful for the advantages that kids in our family have going out into the world that so many kids all over the world simply lack. If you're born in a country that's rich, you're so incredibly lucky, compared to 99% of the world's citizens.
What do you think about the way that successful – often financially successful people are idolized, or emulated by people who hope to achieve similar financial success?
There is a literature on who we emulate. The consistent finding is we look up, not down. There are people all around us. Some of them are doing well. Others are floundering. Who should I imitate? Well, that sounds like an easy question. People who are doing better than me, may be doing better than me because they're lucky, or they had rich parents. On average, they're going to be better people to imitate than people who are doing worse than me. Yeah, I think that's a natural tendency to look up to people who have succeeded. I wouldn't necessarily want to discourage that, but I would –
You want your kids to know that even though there are these spectacular examples of individual success, the most vivid forms of success on a large scale across big populations, come from being a member of a high-functioning team. If you're not a member of a team like that, or if you're a sole practitioner, or if you're even worse, if you're on a bad team, you're not going to succeed.
Now, the high-functioning teams since everybody wants to be on one, they can afford to be extremely selective in their choice of whom they admit to their inner circle. What kind of people are they looking for? They're not looking for people who claim credit for things they didn't really deserve, or people who will lie about what they did on the job just to look good. Ever since the beginning of time, we've had pretty good instincts about who the truth tellers are and who the liars are, even when you can't really have concrete evidence. Just something we can spot about people, and that's another subject I worked on earlier in my career. We're pretty good lay judges of character.
Being a jerk, wanting to succeed only for the sake of succeeding means probably nobody's going to want you on their team if they already have a good team. I'd caution kids to be careful about their idolatry.
How do you think successful individuals should behave differently in an economy where luck plays such an important role in outcomes?
I think, if you recognize that except for good fortune, you would not have succeeded to the extent that you have, really would change the outlook of a lot of successful people I know. It would make them much more gratitude prone for the success they've enjoyed than they currently seem to be. That's an interesting phenomenon in its own right. There's now a burgeoning psychological literature on the effects of experiencing the emotion of gratitude. It's one of those rare fields of study where nobody can find anything negative to say about it. The people who experience gratitude and the way these experiments are conducted are, they can induce feelings of gratitude experimentally. We can put you in a situation where something bad happens to you, and then a stranger comes and helps you. There's a whole variety of manipulations, where we know that we have induced the feeling of gratitude in a person, others involved, keeping a journal, when you write down each evening, what you're grateful for today.
The people in whom gratitude has been induced sleep better, they report elevated levels of subjective well-being, or happiness, if you want to call it that. They are better liked by their friends. They are less likely to suffer from psychosomatic illnesses. There's just no downside that anybody has been able to discover about experiencing the motion of gratitude. If you recognize that except for having been lucky in the various ways I was, I would not have enjoyed the success I did enjoy, you're going to be more grateful and that's going to be a good thing for you. It'll probably make you even more successful. It's not even a downside. It will also make you less stingy about parting with some of the prizes you've won, by virtue of your success, to pay for the investments that will give other people a chance to succeed when they come along.
Yeah, I think being cognizant of the role of luck in your life can only do good things for you. Some would complain, “Oh, then I'll let them tax me more.” So what? If they tax you more and they tax others like you more, you'll still be able to bid just as successfully for that penthouse apartment because relative bidding power is all that counts.
Yes. It's such an interesting concept. You mentioned successful people that you know, what was the response like from very successful people that you may know personally, when your book on Success and Luck came out?
Basically, when a book comes out, nothing happens. You keep hoping there'll be an avalanche of discussion and publicity, but it comes and goes and not much happens. I got a lot of nice notes from people. Many people liked the book and have said nice things about the book. It helped them in various ways to think about their situations. No, I wish it had been a bestseller. I've never had a bestseller in the United States. That's not to bemoan bad luck. I mean, virtually no books do become bestsellers. A lot of them are good, whether mine are or not. You don't need a debate. A lot of good books don't become bestsellers.
The only book I ever wrote that did become a bestseller became a bestseller in several other countries, not in the US. There, I think, there are little quirky explanations for why that was so in each case.
Interesting. Oh, I'm going to ask you about policy and you've touched on it a few times. I want to ask about it more explicitly. Before that, what can people who are listening to the podcast who are maybe realizing that conspicuous consumption is a net negative for society and the consumption arms race is a net negative and that luck plays a big role in successful outcomes. What can people who are realizing those things do themselves as individuals to positively affect the people around them?
Yeah, that's a good question. I would have, until fairly recently said, it's all about policy, that these are things individuals simply can't solve on their own. That's the stock economist position on collective action problems, like the climate crisis. Economists have always been very skeptical of what people call conscious consumption. “Oh, I'm going to drive an electric car. I'm going to ride a bike instead of driving to work. I'm going to become a vegan. I'm going to put solar panels on my rooftop. I'm going to live in a smaller house.” All those things are conscious consumption.
Economists were completely disdainful of it saying that, if you do it, or if you don't do it, the world will be the same either way. Your individual contribution is completely trivial against the scope of the problem that we confront. The only way we're going to solve the climate problem is to have laws requiring green energy and investment in public goods that will result in fewer emissions. I think, we do need those public investments. As a result of work on my most recent book, which is about the role of contagion in behaviour, I've completely changed how I think about the importance of individual action.
Google has a website, it's called Project Sunroof. Type in where you live in, and they'll show you an aerial photograph of your neighbourhood. On the rooftops of the houses in your neighbourhood that have solar panels, they'll mark each one with a red dot. The ones that don't have solar panels, there's no dot. You look at these photos, I've seen hundreds of them. The houses with red dots are almost in every case, either across the street from, or next door to another house with a red dot. The ones that don't have red dots, they're clustered in groups of their own, too. There have been studies now of this. If there's a new installation in a zip code, that's one of our postal codes. If there's a new installation on day one, then in four months’ time, on the average, there will be a copycat installation. That will mean an installation that would not have occurred, except for the fact that people saw that first one.
They take into account the effect of prices, incomes, other determinants of the installation rate. Every four months’ time, if I put solar panels on, there'll be a new installation. Then another four months pass, my installation spawns another copycat. The new one spawns – we got one installation. After four months, we've got two. After eight months, we've got four. After two years, we've got 32 installations, 31 copycats, plus my original one. Did I have an effect with my individual consumption? That's an understatement of my effect. Because the people I influenced are yes, they're my neighbours, but I'm in much closer relationships with family and friends who live in other zip codes. Many more of them will be influenced by my decision to – “What does Frank know? He studies this stuff. He decided was a good idea to do. Maybe I'll do it.”
It's a huge effect when we do these things. We influence other people, often by explosively big magnitudes. There's a second effect that's even more important, I now think, which is that, unlike what my fellow economists and I long assumed, people don't come into the world with fixed tastes and preferences and identities. We gradually become who we are in the process of living our lives.
Aristotle saw that the habits were so important in explaining who people were. If you engage in conscious consumption, if you change your own behaviour, at some cost to yourself, yes, that behaviour by itself doesn't make any difference, just like the economists always said. In addition to influence others to act differently, it also changes who you are. It makes you more likely to knock on doors and write checks to the political candidates who will adopt carbon fees and introduce bills for investments in green electric grids and the like. Yeah, I think I would say, when people ask about individual decisions, I'm much more sympathetic to the possibility that those can be an important step along the policy path that we need to take. We still need the policies, but individual action can help get us there.
All right. On policy, you've mentioned higher taxes a few times. Can you explain your policy position? I also want to ask, because you talked earlier about how you sometimes consider this to be a failure. I'd love to hear about your position. I'd also love to hear about why you think we don't hear much about it.
I have for many decades been touting the attractions of what's called progressive consumption tax. That's probably not a good name for it, because it has the word tax in it, which may be a preview of the answer for why proposals to enact it have not been successful. People don't like the idea of a consumption tax, because they think of a sales tax when they hear the word consumption tax. A sales tax is regressive. It hits the poor much harder than hits others.
All that's true, I do not propose a sales tax. I propose a progressive consumption tax and that's very different. The way it works is fairly simple. You report your income to the tax authorities as you do now. Of course, it would behoove us to greatly simplify the reporting process. We should do that. I hope we will. we could leave it just like it is now. No change there. Then, the next step would be you document how much you had augmented your savings during the year in much the same way as you currently do for tax exempt retirement accounts.
In the US, we have those. I don't know the institutional framework in Canada as well, but I assume you have similar things there. Then the difference between those two numbers, your income as reported, the increase in your savings as reported, income minus your savings, that's how much you spent during the year. I think when we think about taxing personal consumption expenditure people, we're going to have to save receipts for everything we bought and show what we spend our money on. No, how much did you earn in total? How much did you save? The difference, that's your consumption.
Then, we take a big standard exemption off of that, $10,000 a person maybe, and that's your taxable consumption. The tax rate starts out zero when that's a small number. Then it grows gradually. It only gets big once your taxable consumption number gets really large. At that point, it can grow much higher than the tax rate on the next dollar of income, because we're not no longer worried about choking off savings in investment. On the contrary, higher taxes on consumption stimulate savings and investment because savings is tax exempt. You're not taxed on your savings until you spend it.
Well, people say, “Oh, the rich, they've got so much money, they're not going spend it all anyway. They would just ignore the effect of a tax like that and go on spending what they do.” No. I think, there's good evidence against that claim. You're about to put a 2 million dollar wing on your mansion, now a progressive consumption tax is announced it's going to take effect in the next month before you can get your project built. What do you do? It's going to be a marginal tax rate of a 100%. You're consuming already 5 million dollars a year, the tax rate on the next dollar you spend is a 100%.
Are you going to build a 2 million addition? Or are you going to say, “Well, maybe I'll scale back a little bit.” You and others like you are going to scale back and how do we know that? Because in New York City, the most expensive real estate market in the world where there are lots and lots of billionaires, billionaires, or even fake billionaires, don't live in 30,000 square feet, they live in 10,000 square feet. Why? Because real estate per square foot is so much higher in New York, that 10,000 square feet feels like a huge place in New York. You want a huge place? 10,000 feet gets you one. Donald Trump's apartment is 11,000 square feet. He claims to be a billionaire for raising bank loans. He says, his apartment is 33,000 square feet. It's not. It's 11,000 square feet. In New York that's still really, really big.
We know people would scale back. That's the Ferrari-Porsche example writ large. If you had that tax in effect, the spending at the top would grow less rapidly. I mean, ideally, you'd phase this in during a recession if you wanted to stimulate spending. You could say, well, a progressive consumption tax is coming, as soon as unemployment gets back down below four and a half percent again. Well, we better build that mansion now. You'd have a tax free stimulus plan on your hands.
Our final question for you, Professor. How do you define success in your life?
That's an interesting and difficult question. We had a good friend who died some years ago, and we had mutual friends. There would be friends we had in common who would do something disappointing and we would feel bad that they hadn't done what we thought was be the right thing. Dorothy would always say in situations like that, people do what they can. I think it's important to be forgiving of others. Don't imagine that everybody's ideally positioned to do the best possible thing at every moment. We're all flawed creatures.
I try to tell myself to be a little more forgiving when I think about how things have gone. I think, by at least some standards, I could say that I left things better than how I found them. I think, what I can't say is that I did everything I could and I feel bad that I feel like I could have done more. If I had been a little less lazy or a little bit more focused or organized, I could have gotten more done with the good fortune that came my way. Yeah, I think you should be hard on yourself, but not too hard on yourself, I guess is the way I should think to respond to a question like that. How you should feel about things looking back.
This has been great. Thanks so much for joining us. I got to say, it's funny to hear you say that. As someone who has not written a book but would love to one day, to hear you say that you wish you would have accomplished more, given the number of books and the widely adopted textbook that you have, I mean, it's – You've accomplished a ton from where I sit.
I think, context matters. For many, many years, Richard Thaler and I were close colleagues here at Cornell, he has recommended that governments around the world change their policies about what he and Cass Sunstein called the nudge policies. Governments around the world have adopted that and it's been a great thing. They've made progress by doing that. I've said, “Governments around the world should adopt a progressive consumption tax”, and nobody's adopting them.
When I think about my own performance in that context, it's easy to feel that well, shouldn't I have done more? Can I've gotten a better outcome than I got? Yeah, I think I do take my friends advice, not to be too hard on myself.
Awesome, well this has been a great conversation. Thanks so much for joining.
I’ve really enjoyed to have a chance to chat with you both.
Thanks again and great to meet you.
Is there an error in the transcript? Let us know! Email us at info@rationalreminder.ca.
Be sure to add the episode number for reference.
Participate in our Community Discussion about this Episode:
Books From Today’s Episode:
Success and Luck — https://amzn.to/3uAuFsx
Luxury Fever — https://amzn.to/3h5uG4D
Principles of Economics — https://amzn.to/3BcHrBd
The Winner-Take-All Society — https://amzn.to/3h4lxcD
Links From Today’s Episode:
Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/
Shop Merch — https://shop.rationalreminder.ca/
Join the Community — https://community.rationalreminder.ca/
Follow us on Twitter — https://twitter.com/RationalRemind
Follow us on Instagram — @rationalreminder
Benjamin on Twitter — https://twitter.com/benjaminwfelix
Cameron on Twitter — https://twitter.com/CameronPassmore
Prof. Robert Frank on Twitter — https://twitter.com/econnaturalist