In truth, investors profit relatively little from their creations. A study by the Yale economist William Nordhaus concludes, “Only a miniscule fraction of the social returns from technological advances over the 1948–2001 period was captured by producers indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.” Nordhaus estimates that innovative producers capture less than 5 percent of the value their inventions create for society.[i] And those are the innovators who succeed!
Nordhaus cautions: “The low appropriability of innovation should caution investors about committing the alchemist fallacy. . . . Some believed that such a virtual substance had been found in the electronic world [or in the information world as the case may be]. But the laws of economics teach us that were anyone to find such a miraculous substance, its value would quickly fall. . . . In retrospect, the laws of economics look like a safer bet than the lure of alchemy.”[ii]
Because the benefits of innovation garnered by the public are far greater than the payoff captured by successful innovators, it is surprising how eager the advocates of redistribution are to maximize taxes collected from innovators rather than to maximize the pace of innovation. They focus on the tail instead of the dog. Tax policy that seeks to maximize tax revenues in the short run is horribly shortsighted. A more logical policy seeks to maximize the pace of innovation and the benefits captured by the middle and working classes in the long run.
In my previous book, I argued that redistribution hurts the middle and working classes because they forgo more value from lost investment than they reclaim from redistributed income. While I argued that investment likely produces 20 times more value for consumers and workers than is captured by investors—in line with Nordhaus’s estimates—my analysis was based on consumers and workers capturing only 3.8 to 5.7 times more value than investors.[iii] I reasoned that no one would dispute estimates that conservative.
The New York Times erroneously reported (although perhaps intentionally so) that a 20-times multiplier was “crucial” to my argument.[iv] The reporter admitted that “the idea that society benefits when investors compete successfully is pretty widely accepted.”[v] The article used Dean Baker, “a prominent progressive economist with the Center for Economic and Policy Research,”[vi] as expert testimony to dispute the 20:1 multiplier. The article reported: “Baker estimates the ratio is 5 to 1, meaning that for every dollar an investor earns, the public receives the equivalent of $5 of value.”[vii] Ironically, that’s essentially the value I assumed in my calculations to avoid disputes with liberal economists like Dean Baker! . . .
At Nordhaus’s 20:1 ratio, the value of investment to noninvestors obviously overwhelms the value of redistribution for all but the poorest households—households that only participate indirectly in the economy through redistribution.
[i] William D. Nordhaus, “Schumpeterian Profits and the Alchemist Fallacy,” Yale Economic Applications and Policy Discussion Paper No. 6, April 2, 2005, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=820309.
[iii] Edward Conard, Unintended Consequences: Why Everything You’ve Been Told About the Economy Is Wrong (New York: Portfolio, 2012), 255.
[iv]Adam Davidson, “The Purpose of Spectacular Wealth, According to a Spectacularly Wealthy Guy,” New York Times Magazine, May 1, 2012, http://www.nytimes.com/2012/05/06/magazine/romneys-former-bain-partner-makes-a-case-for-inequality.html?pagewanted=1&ref=magazine&_r=0.