The top 1% on EconTalk

by Russ Roberts on November 7, 2011

in Financial Markets, Standard of Living, Work

This week’s EconTalk guest is Steven Kaplan talking about the top 1%. He and co-author Joshua Rauh gathered as much data as they could about the composition of the top 1%. They get all of the CEO’s of publicly-traded companies, the richest hedge fund managers, Wall Street execs, athletes, celebrities and some lawyers. They miss some lawyers, some celebs, execs and owners of privately-held companies. Kaplan argues that the richest Americans today are richer than the richest Americans of the past is because of globalization (scale to use one’s talents) and technology.

I pushed the idea that creditor bailouts let Wall Street execs use more leverage and enhance their pay. He didn’t like the idea much. We have a nice back and forth towards the end.

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Jon Murphy November 7, 2011 at 11:43 am

Sounds good. I look forward to listening to it on my drive home

Dave November 7, 2011 at 11:59 am

Funny, I made a (somewhat off-topic) comment that hit on these issues at EconLog over the weekend. Regarding the importance of process over outcomes, I wrote:

“I have the same attitude when it comes to income inequality: I don’t necessarily think it matters, but I care about the causes of the inequality when making a judgment. Did it arise because a banker made millions taking on systemically important tail risk for years, implicitly covered by taxpayers? Was it a result of a credit bubble aided by artificially low interest rates from the Fed? Then yes, we should be concerned with it. But if it is simply because cheaper national or global distribution allows larger returns to the most talented people in their industries (think movie stars, software entrepreneurs), then that seems like a fair process. And I think we can infer that liberals agree to some extent since there is no Occupy Hollywood or Occupy Silicon Valley movements.”

These ideas were also explored by Robert Frank (and others) a while ago. The Winner Take All Society put forward a similar idea in 1995 regarding scale. Anyway, looking forward to the podcast.

Shelby November 7, 2011 at 12:17 pm

Dave -
“And I think we can infer that liberals agree to some extent since there is no Occupy Hollywood or Occupy Silicon Valley movements.”

I’m not convinced that the liberals agree that any market transaction is a “fair process.” However, if they Occupy either of the above, they might reveal their ignorance, hypocrisy, or both.

GAAPrulesIFRSdrools November 7, 2011 at 2:14 pm

I’m not convinced that the liberals agree that any market transaction is a “fair process.”

It actually goes beyond that. The left doesn’t think ANY human activity is “fair”. Remember the mother of sexual harassment-Catharine MacKinnon-one posited that it is incapable for a woman to engage in physical intimacy with a man voluntarily, because he can always resort to force.

SmoledMan November 7, 2011 at 4:15 pm

I’m still waiting for the Occupy Apple event right outside the 5th Ave Cube store.

Jon Murphy November 7, 2011 at 4:19 pm

Yeah, I wonder when the Occupy people will realize Steve Jobs was the embodiment of those they resent: he manipulated stock prices, charged ridiculous prices, bullied those who voiced dissent, was one of the most powerful business voices in Washington, and “exploits” helpless Chinese workers.

Doc Merlin November 7, 2011 at 8:53 pm

He was “cool” though. Which covers a multitude of sins.

Jon Murphy November 7, 2011 at 8:57 pm

Apparently. That’s probably why the OWS people are targeting bankers and not celebs or athletes.

PrometheeFeu November 8, 2011 at 4:17 pm

Well, that and the banks took way more taxpayer money than Steve Jobs.

Ryan Vann November 7, 2011 at 12:12 pm

” pushed the idea that creditor bailouts let Wall Street execs use more leverage and enhance their pay.”

I’m not sure how anyone could deny this. However, just looking at creditor bailouts misses the larger story. Most banking policies in the last century and a half have been aimed towards essentially encouraging more and more leveraging. The bias towards debt is even ingrained in the US tax code. In short, no implicit or explicit guarantees and stop taxing equity.

Methinks1776 November 7, 2011 at 12:35 pm

Most banking policies in the last century and a half have been aimed towards essentially encouraging more and more leveraging.

Yep. By shifting risk.

The problem with reversing that is it’ll cause massive deleveraging, which is hugely deflationary. Neither asset owners nor government want that. We’re stuck until the whole thing blows up, IMO.

kyle8 November 7, 2011 at 1:33 pm

This is one of the few areas where I think some government regulations make sense. Not the ones we actually have by any means, But rather sound credit regulations that would require proof of pay-ability or collateral and larger down payments especially for real estate but also for the purchase of financial instruments.

The single biggest factor in any and every economic downturn is debt. In this case, your debt, my debt, and the debt of every company can amount to a failure of the commons. So I think government has some responsibility.

Of course the problem remains that government is often inept or corrupt in it’s regulatory schemes.

GAAPrulesIFRSdrools November 7, 2011 at 2:30 pm

“But rather sound credit regulations that would require proof of pay-ability ”

Kyle, it is impossible for any party (even the lender, when they retain “skin in the game” and don’t intend to sell or package the loan) to establish capacity for repayment from present circumstances. Forget the government, who lacks both incentive and expertise in lending.

All we can do is utilze heuristics (rules of thumb) that provide some indication of the creditworthiness of the loan. Actually, the big factor would be character and unless you have a criminal record and the lender is allowed to inquire and check, that’s completely immeasurable.

Remember there are Type I and Type II errors. In the early sixties, there was a drug thalidomide-that was associated (to the point that causation was virtually indisputable) with children born without limbs. The reaction was increased FDA scrutiny that arguably prevented some safe and efficacious drugs from coming to market.

Everybody is an individual. There are no one-size-fits-all rules that will assure any given level of repayment without risking excluding people. The best assurance of prudence is to assure that the lender “feels the pain” of a default.

Methinks1776 November 7, 2011 at 2:35 pm

But rather sound credit regulations that would require proof of pay-ability or collateral and larger down payments especially for real estate but also for the purchase of financial instruments.

The reason those sound decisions are gone with the wind is because government stepped in with all kinds of regulations and its associated problems.

If you’re lending money without a safety net, you will do your due diligence. Why wouldn’t you? What makes you think that a busy body with no skin in the game (a regulator) will be able to set better standards for you than you will for yourself? With a safety net (and government mandates to boot), you may not be so cautious. There’s no pay-off for caution.

There’s no sounder regulation than a painful bitch slap by reality.

Risk needs to be shifted back to wher

vikingvista November 7, 2011 at 5:56 pm

“debt … can amount to a failure of the commons.”

It is not by any stretch a “failure of the commons”, because it isn’t a commons. Debt has clearly defined property ownership criteria. Default results in identifiable previously agreed to property transfers. As such, the property owners themselves are the best equipped from both an incentive and knowledge standpoint to deal with such arrangements. Neither party in a default wanted that result, but it is not at all a commons, nor is it anybody else’s business.

If you want government to do anything about debt (and I don’t), it should be merely to stop distorting the signals that the property owners depend upon.

kyle8 November 8, 2011 at 8:30 am

I would agree with your last statement to some extent, but I still think requiring down payments for instance might be a good thing.

I do however disagree about a problem of the commons. I never got into any significant debt. However my well being has been negatively impacted by the huge amount of defaulted debt of others which crashed the economy.

vikingvista November 8, 2011 at 11:20 am

That does not make it a commons, I’m afraid. You may not like a market where you can’t get a hamburger at a decent price either, but that doesn’t mean there is any common or non-ownership of the property involved, or that it is any of your business to force people to behave in a way to make it available to you. Merely being affected by the decisions of others doesn’t mean a commons is involved. You are misusing the term.

Nor is this an example to support of the idea that you (and enough people who agree with you) should want to impose your will upon other property owners. That is, it is because of such a mentality that the market was distorted to the point that such widespread undervalued risk and massive coordinated defaults even occurred.

In other words, if you really seek protection against such events, you should be opposing your very mentality.

Ryan Vann November 7, 2011 at 2:03 pm

“Neither asset owners nor government want that. We’re stuck until the whole thing blows up, IMO.”

Perhaps, I still think that at least putting equity financing on a level tax ground with debt would be a decent policy. There might be some other non-armageddon policies to enact, but they might ultimately be futile.

Methinks1776 November 7, 2011 at 2:28 pm

I don’t see a justification for that. Equity holders are residual owners. Bondholders have priority. Paying off the debt is part of the cost of doing business because it must be paid. There is no such obligation to equity holders.

There are natural limits on debt financing. Creditors will demand a higher interest rate to compensate them for additional risk as the debt/equity ratio deteriorates, until obtaining debt financing costs as much as attracting equity financing.

Ryan Vann November 7, 2011 at 2:36 pm

You are describing the law as it exists now. My view is that as far as obligations go, the order is fine as it stands now (workers, vendors, bondholders, equity holders), but tax implications are a compeltely different issue.

“There are natural limits on debt financing. Creditors will demand a higher interest rate to compensate them for additional risk as the debt/equity ratio deteriorates, until obtaining debt financing costs as much as attracting equity financing.”

It’s a good theory, but in recent years, haven’t we observed the exact opposite?

Methinks1776 November 7, 2011 at 3:21 pm

You’ve only observed the complete opposite for a handful of too big to fails.

The difference in tax treatment come from the fact that debt service is one of the normal costs of business. Just like any obligation the firm has, including payroll and rent. That is as it should be unless you can come up with a good reason why debt service should not be treated as a cost of doing business.

No company is ever required to pay its equity investors anything, thus anything left over after the normal cost of doing business is distributed on an after tax basis. Elimination of corporate taxes won’t put them on equal footing.

kyle8 November 8, 2011 at 8:34 am

I still think that discouraging debt in favor of equity would be a good thing. Debt is not our friend. I view debt the same way I view government, nuclear power, and fire.

We need and can safely use all of these things, but we should be very cautious with them, they can get out of control easily and consume us.

vikingvista November 8, 2011 at 11:36 am


You put the government in control of food, you get starvation. That doesn’t mean that food is dangerous and needs strict government controls. It means the exact opposite.

Methinks1776 November 8, 2011 at 9:35 pm


Besides wholeheartedly agreeing with everything Vikingvista wrote in response to you, I add that there are natural deterrents to overleveraging. Deterrents that government is busy removing and that’s when debt becomes toxic.

Of course, it’s still possible to underestimate risk, but no government lackey is better at calculating risk than anyone else. why should a perfectly good form of financing be meddled with by drooling bureaucrats?

The only thing I’d like to see government involved with in terms of debt, is cutting down how much it borrows.

WhiskeyJim November 10, 2011 at 10:33 am


Well, you are right. But the government is preventing the market from clearing by spending trillions in debt. The Fed the same.

Personally, I’d rather we ripped the bandage off right quick, rather than going into debt slavery and suffering through stagnation for a decade.

After all, the unfunded liabilities of government are coming at us like a tsunami.

Chris O'Leary November 7, 2011 at 12:28 pm

My business is proof of several of the themes that are discussed here, including the benefits of free trade and globalization (or just plain non-state-ization). I sell hitting and pitching instructional DVDs, and 98% of my sales are to people from outside of the state of Missouri, where I live, and 99.5% of my sales are to people from outside of the city of St. Louis.

I am making a decent living as a result of free trade and technological advances that facilitate it and would have long ago gone out of business if not for the benefits of free trade and technology.

P.S. And, to my knowledge, I’m doing all of this while not exploiting anyone.

Bastiat Smith November 7, 2011 at 1:02 pm

(Tongue in cheek)
You are exploiting all of the domestic consumers in other states and cities. How can they be expected to purchase domestically, when you are good at what you do? This the the selling of [insert city/state] where they pay their money to foreigners who have an unfair advantage. You are exploiting the consumers who don’t know any better than to buy exactly what they want at the lowest price, rather than buy the ‘right’ goods produced by a more local supplier.

I bet you’re employing capital instead of people too! ;-)

Methinks1776 November 7, 2011 at 12:49 pm


TBTF are a small number of very large corporations. The top 1% is what? 3 million households? Even if the CEOs of those companies were counting on bailouts (and, having worked on Wall Street for a long time, it’s not my impression that this was at the front of their minds if it was a glimmer of a thought at all), they account for a tiny minority of the top 1%.

Technology has completely changed my business. In the past, I would have to physically stand on the floor and I was limited to trading only as many products as the number of crowds on the same exchange I could physically walk to (just a handful of products). And that required the use of clerks. Today, I sit in front of a huge bank of monitors and I can trade hundreds of products (as well as nip into the Cafe when it’s slow) – all without moving anything but my neck. Furthermore, if one product becomes too competitive, I can easily switch to another one and that has made the quality of earnings better as well. I can also easily connect electronically to any exchange in the world. It’s easier to trade in Hong Kong, Singapore and in London than it ever has been. The ability to connect to exchanges electronically has allowed us to scale tremendously, relying less on a the most expensive input – labour. I don’t know how much incremental leverage it would take to equal the effect electronic trading has had on wealth creation.

Methinks1776 November 7, 2011 at 12:54 pm

BTW, electronic trading has also allowed people like me to be successful in a profession that was dominated by giant, loud men. On the floor of an exchange, you must be seen and heard to participate in a trade. Thus, most of the people on the floor were very tall, large men who roared like lions. As a small woman, I was at a significant disadvantage. Electronic trading eliminated the physical advantage and opened up the business to a larger number of people. As a result, it has become more competitive and margins have been squeezed. Competition works its magic.

Chris O'Leary November 7, 2011 at 5:18 pm

But what about the fates of the tall, large men that you displaced!!! ;-)

kyle8 November 7, 2011 at 1:25 pm

Yes, of course. I have pointed out to some students that the economies of scale are at work here in a global community.

In the nineteenth century if you had a good product or you owned a large retail shop you could be a big man in your city or region and probably never become a millionaire.

Later in the twentieth century it became much easier to sell to the entire nation. There was also more population and more wealth. And you could build a chain of stores or franchise your product. During this time profit margins did not increase, in fact they may have fell, but many people became millionaires.

Now, if you have a product or service you are not bound by either national borders or in many cases (internet companies) are you even bound by physical plant. Now with very small margins you can become a billionaire and there are more of them all of the time.

This is not because they are nefarious and are somehow stealing their wealth from others. It is simply a matter of scale.

Economic Freedom November 7, 2011 at 1:38 pm

Steven Kaplan said something to effect that he wasn’t going to judge whether the super rich have or make too much. I wonder why he is so hesitant to see excess wealth and income for what it is A ZERO SUM GAME. If you want to look at the zero part, you can start with the 50,000,000 American who live in poverty.

Jon Murphy November 7, 2011 at 1:55 pm

To think wealth is a zero sum game is to highlight your lack of understanding of economics.

Economic Freedom November 7, 2011 at 1:58 pm

You are blind to the poverty all around you. You choose to ignore it; that makes you a foul librarian who lacks understanding of the human condition. When you become homeless and hungry, then we can talk. Until then, you have no moral standing to speak.

GAAPrulesIFRSdrools November 7, 2011 at 2:40 pm

When you become homeless and hungry, then we can talk. Until then, you have no moral standing to speak.

And when you take your meds and get a job and start paying taxes and realize you are going without because lunatics keep grabbing your earnings you’ll have moral standing.

GAAPrulesIFRSdrools November 7, 2011 at 2:38 pm

And to speak of “excess wealth” as a numerical number, rather than having a character received by force or deception, shows just how right Mr. Jacoby was in writing this in his column on Nov. 2.

“Economic envy may cloak itself in rhetoric about ‘inequality’ or ‘egalitarianism’ or ‘redistribution of wealth,’ but its oldest name is covetousness.

Jon Murphy November 7, 2011 at 2:38 pm

If wealth is a zero sum game, than an economy could not grow. Transactions would not occur, as there would be a winner and a loser. No one would want to lose, no no one would interact with one another.

Your blatant ignorance (or willful blindness) is an insult and a burden upon those you claim to serve.

Shame on you for perpetuating global poverty and global hunger. Shame

Darren November 7, 2011 at 6:19 pm

If wealth is a zero sum game, than an economy could not grow.

If wealth was a zero sum game, we’d still be living in caves. BTW, I think this was supposed to be a spoof of some kind.

Jack Fraser November 7, 2011 at 2:20 pm

If transactions were a zero sum game, why would we ever transact for anything more than the absolute necessities? 49 million Americans may require food stamps, a sad fact, but I think you’re seeing correlations as causation. Once you bake in utility to any transaction, even a pure stock trade, the result of an exchange is usually to make both parties better off. If I sell you a security, I might be reducing my risk, while you wish to increase yours. Even though the future profits from appreciation will only go to one of us, both of us get something they want, at least for now. EG I sell an interest rate swap to a client and if we held it (ha ha ha), our gain would be their loss and vice versa. But, what they lose in potential interest savings, they gain in forecasting ability and the ability to reduce losses in the event of a rise in interest rates.

I would also point out we define poverty in our country differently than the more commonly quoted figures which tend to follow the $1/day threshold, while for a single earner, ours seem to be more like $30/day. I believe food stamps offer $1.50 a meal and $4.50/day. Not a large amount at all. I would have trouble paying for the soup in my lunch in Manhattan for that much money. However, in other parts of the country, 4.50 a day might get you some basic staples such as lentils, rice and beans and in relatively large quantities. I know it’s not much, having been impoverished at one point in my life, but in the past and elsewhere, such food was the object of one’s entire labor efforts. Any extra money can go toward a number of life’s necessities, a number of which have either gotten cheaper or of higher quality in the last century or so. Given the improvement to basic objects and living standards, I’d hardly argue our entire society is somehow zero sum.

Jon Murphy November 7, 2011 at 2:50 pm

Nothing teaches you humility like poverty.

The closest I’ve come is living off $10/day in college, but fortunately all I had to pay for was food.

Economic Freedom November 7, 2011 at 1:46 pm

Maybe, this epoch will be remembered at the “Great Contraction,” to distinguish itself from the G8 Depression. He is an example from Michigan, where they are ripping the streetlights out of the ground. This seems like an intentional “broken window”. Vandals will also steal streetlights to sell the metal and copper wire for scrap.

muirgeo November 7, 2011 at 3:04 pm
mcwop November 7, 2011 at 3:58 pm

99% could easily vote the bums out of office, but they don’t. Baltimore is a perfect example. A city ruled by Democrats for decades. We have high crime, high drug usage, high poverty, some of the worst schools in the country, and the highest tax rates in the state. Occupy has supported these bums for decades, so I ain’t holding out much hope from OWS.

Jon Murphy November 7, 2011 at 4:00 pm

But they don’t ’cause the 99% doesn’t speak with one voice. The 99% are individuals, each with his own beliefs and values. The arrogance of the OWS people to say they speak for all the 99%.

vikingvista November 7, 2011 at 5:46 pm

I think they are referring to 99% of dipshits.

Invisible Backhand November 7, 2011 at 4:02 pm

I listened. I found it interesting that your confirmed bias (moral hazard of a guaranteed bailout) was dashed upon the shore of data (their options were ordinary income taxed at 50%* and the stocks sold off to pay taxes)

*please listen to the podcast first

Invisible Backhand November 8, 2011 at 12:33 pm

“The same two considerations hold against the TBTF theory of the crisis, which, like the corporate-compensation theory, is an economistic, moral-hazard story that presupposes that managers of the largest banks were well informed about the objective (ex post) level of risk they were taking (e.g., Volcker 2010, 12). As Stiglitz (2010a, 164, his emphasis) puts it (again without providing evidence), banks ‘‘ knew they were too big to fail, and consequently they undertook risk just as economic theory predicted they would.’’ In other words, the reason the bankers knowingly took risky bets is that they also ‘‘knew’’ they would be bailed out if the bets went sour. Had this been the case, however, the bankers would have levered their bets to the legal maximum; and they would have bought disproportionate quantities of bonds from the high-yielding mezzanine tranches of PLMBS and CDOs, not from comparatively low-yielding triple-A PLMBS and CDO tranches and even lower-yielding agency bonds.

The TBTF theory also suffers from defects of logic and evidence that do not apply to the corporate-compensation theory. First, the evidence for the TBTF theory consists mainly of two historical episodes, the bailouts of Continental Illinois Bank in 1985 and of a hedge fund, Long-Term Capital Management (LTCM), in 1998. These episodes are supposed to have assured executives at the largest commercial banks that they, too, would be bailed out. However, when Continental Illinois failed, its managers were fired and its shareholders were wiped out, and when LTCM was bailed out, its principals were essentially wiped out, too. It would not be logical for any self-interested bank executive to run a bank into the ground because of his or her belief that it would then be bailed out if she would then be fired (and, if compensated with equities, wiped out). Not only does public obloquy follow from destroying a major bank, but ‘‘the reputational impact of insolvency is likely to include the loss of opportunities to manage another banking firm or to be appointed to the board of other banking firms’’ (Mehran and Rosenberg 2009, 8–9). In addition, ‘‘a higher standard of accountability according to law and well-defined regulatory expectations for bank CEOs (and bank directors) can facilitate their prosecution relative to non-bank CEOs.’’ It is therefore not at all obvious that the incentives created by the Continental Illinois and LTCM bailouts were in favor of risk taking at other TBTF banks. If anything, the leverage ratios and asset 44 Chapter 1 composition of the banks suggest that bankers might have taken quite the opposite lesson from those bailouts.”

Engineering the Financial Crisis, Friedman & Kraus

Martin Brock November 7, 2011 at 4:13 pm

Kaplan argues that the richest Americans today are richer than the richest Americans of the past is because of globalization (scale to use one’s talents) and technology.

This conclusion only raises many questions. If technology distributing talents more widely is the reason for rising inequality, why don’t the lion’s share of the rewards flow to the people contributing this technology?

If a thousand people see Babe Ruth hit a home run, he’s wealthy. If a million people see it, he’s much wealthier, but he hits the same ball with the same bat and runs around the same bases. He doesn’t run around the world distributing video of the home run. Other people do that.

Countless forcible proprieties, from broadcast frequency monopolies to copyrights and taxpayer-financed baseball stadiums, channel value toward particular factors of production. The marginal value of a particular factor is a product of all of these forces. It is not an intrinsic property of the factor.

Similarly, the water flowing over Niagara Falls is the product of many forces channeling water upstream, and these forces are now more artificial than natural. Over half of the water that would naturally flow over the falls is now diverted to generate hydro power.

The state creates great wealth. The state has has always created great wealth, and the state will always create great wealth.

I’m not saying that the state should not create great wealth. I’m only noting that it does as a matter of fact.

mcwop November 7, 2011 at 4:24 pm

“He doesn’t run around the world distributing video of the home run.”

No others do that and some get rich off of it. Yes the state is involved, after all, baseball is a government protected monopoly. But there is no reason why Babe should not be able to get rich off of his talents.

Martin Brock November 7, 2011 at 4:39 pm

… there is no reason why Babe should not be able to get rich off of his talents.

Well, it doesn’t violate laws of Physics …

The shouldness of it all is not my point. I have my personal shoulds and shouldn’ts, but I don’t pretend to know the shouldness of it all. Even if I did, forcible propriety has more to do with politics than with ethics as a practical matter, and I don’t much equate politics with ethics.

Invisible Backhand November 8, 2011 at 2:05 pm

Psst…don’t tell these libertarians baseball players have a very successful union.

vikingvista November 7, 2011 at 5:36 pm

A better word than “technology” would’ve been “productivity”, which flows from capital investment. Much of the rewards do flow to the investors. A larger market means a larger return on productivity gains.

Martin Brock November 7, 2011 at 7:52 pm

Technology increases productivity, enabling the same resources to produce more wealth, but we aren’t discussing the volume of wealth produced. We’re discussing the volume of wealth that particular factors of production are entitled to claim.

If copyrights didn’t exist, millions of copies of a Babe Ruth home run might still be produced, and millions of people might still pay to watch a copy, but Babe Ruth himself would claim less of this value. He’d still be wealthy, but he’d be less wealthy.

And copyrights needn’t cease to exist to change the distribution of this wealth. A different copyright standard distributes the wealth differently. For example, instead of threatening to harm people copying an image of Babe Ruth’s home run without Ruth’s consent for 120 years, the state might only threaten to harm people for 14 years, as it did under the first copyright law in the U.S., or it might only threaten to harm people until Ruth receives a million dollars in royalties. Countless copyright models are conceivable, and each delivers different income to Ruth.

Martin Brock November 7, 2011 at 4:18 pm

Correction: The state channels wealth to the wealthiest proprietors. The state has always channeled wealth to the wealthiest proprietors, and the state will always channel wealth to the wealthiest proprietors.

Jon Murphy November 7, 2011 at 4:19 pm

As long as it has the power

Doc Merlin November 7, 2011 at 8:56 pm

Of couse if Mandelbraut is correct. All financial risk is effectively tail risk (oh the suckitude of Levy distributions).

Martin Brock November 8, 2011 at 10:28 am

Does Mandelbrot say that financial risk is fat-tailed? I suppose it is as a practical matter, because markets are efficient, and the distribution of yields in an efficient market is roughly a Pareto distribution or a log-Normal distribution with a large (ever increasing) dispersion parameter.

I wasn’t sure of the precise definition of “tail risk” in finance, so I googled for the term and read the Wikipedia article.

“Tail risk is the risk of an asset or portfolio of assets moving more than 3 standard deviations from its current price in a probability density function.”

Wikipedia cites Investopedia for this definition and goes on to say, “This is often under estimated using normal statistical methods for calculating the probability of changes in the price of financial assets.”

But the fat-tailed probability distributions violating the assumptions of normal statistical methods (the central limit theorem) don’t have a standard deviation at all. These distributions don’t even have a mathematical mean. “Underestimation” is a misnomer in this context. The standard deviation of a fat-tailed distribution cannot be estimated because it doesn’t exist.

Miles Stevenson November 7, 2011 at 9:14 pm

It was a great discussion and I hope to hear more. Kudos to Kaplan for making a good case about the 50% taxation and the history of recessions, as well as Russ for not denying the data and admitting that it is compelling and worth looking at. I really hope you guys do another episode.

cmaehler November 7, 2011 at 10:50 pm

I normally don’t post on podcast but this was a really bad one, Kaplan was really bad at explaining his point and I was left with what was the point feeling. So is the 1% greedy insiders or is it just the billion dollar Hedge Fund Managers just really talented people. He never seemed to answer your question, are the 1% earners just taking advantage of the system which make them rich or are they making our world a better place through the allocation of capital.

Martin Brock November 8, 2011 at 9:58 am

Billion dollar hedge fund managers can be really talented rent seekers, and the return to rent seeking continually increases.

MF Global declared bankruptcy days after a small committee of European politicians announced a bailout plan for a European state. Reportedly, the fund failed, because the bailout plan requires some Greek creditors to write off half of their principal. Apparently, the fund bet heavily against this outcome, by purchasing the bonds at a smaller discount or selling default swaps or something. Others bet differently on the same outcome.

Rent seeking doesn’t guarantee riches any more than genuine investment, but betting on a political outcome, typically while seeking to influence the outcome, is the essence of rent seeking. If Corzine bets on a different outcome and profits from his bet, he’s still a rent seeker. If he doesn’t seek to influence the outcome (which is hard to imagine), he is still a rent seeker.

Profit from rent seeking is not evidence of more productive resource organization. It can easily signal the opposite. The talent of the rent seekers is beside the point. If the most talented people didn’t seek rents, slightly less talented people would seek the rents instead. The point is that rent seeking in general is not productive. Attracting more talent into the business is hardly cause for celebration.

Martin Brock November 8, 2011 at 7:31 am

I finished listening to the podcast this morning, and my conclusion is little changed. Kaplan is essentially an apologist for wealthy proprietors. Much of economics generally is this sort of apologetics, so Kaplan is in good company.

The story goes like this. The state continually threatens to harm people for crossing ever longer lines of ever increasing complexity, a veritable Mandelbrot set of forcible proprieties; however, since the statesmen title their lines “proper”, we just take that for granted. We’d rather not talk about it. The talk is vulgar. It smacks of envying the powerful. The Pope says that’s a sin, and we all know he’s infallible, because he says he is.

After all, we may bargain with whatever liberty we have left. Since market forces govern what the statesmen do not rule out by statutory force, we may safely, and often profitably, discuss every bargain in terms of the market forces involved while simply ignoring the statutory forces.

This selective focus creates an illusion that market forces dominate, even while the state sector directly controls, through direct state expenditure, an ever growing share of economic output, approaching half of everything anyone produces, and indirectly controls even more.

Kaplan makes this story laughably plain by comparing the rising income of corporate CEOs to the rising income of lawyers. “Look,” he says, “the income of lawyers rises as fast as the income of CEOs, so how can you say that politics explains the increase?” Is he serious? I’m not supposed to laugh at the absurdity of this proposition?

Lawyers make their living by carefully studying the decrees of statesmen and exploring the particulars of obligations they impose, and there’s little difference between a lawyer and a CEO. Right. That’s precisely the point.

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