Capitalists Get Rich but Consumers Capture the Benefits

Yale University economist William Nordhaus is co-winner, along with NYU’s Paul Romer, of the 2018 Nobel Prize in Economic Sciences. Nordhaus is most famous for rigorously analyzing how climate change will likely affect long-run economic growth.

Although he recommends a tax on carbon in order to diminish any negative impact that climate change might have on economic growth, because Nordhaus is a first-rate economist he understands two truths that typically are ignored in overheated public discussions of climate change. First, given that there are very real advantages to human activities that promote climate change, the optimal amount of climate change is greater than zero. Second, much uncertainty attends even his own careful empirical estimates of the “optimal” carbon-tax level.

Together, these two truths warn us that the costs of any actual government policies to reduce climate change might exceed the costs of whatever changes in climate those policies avert.

Sharing the Benefits of Innovation

Less well-known than Nordhaus’s work on climate change, but every bit as interesting and important, is his research on the benefits of innovation. In his 2004 paper “Schumpeterian Profits in the American Economy: Theory and Measurement,” Nordhaus reported this startling finding about the non-farm sector of the modern U.S. economy: “Only a minuscule 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.”

Specifically, producers, on average, capture a mere 2.2 percent of the total benefits of their successful introduction into markets of technological advances. A whopping 97.8 percent of those benefits are enjoyed by people each of whom as a consumer did nothing other than exercise his right to spend his money on those options that he judges best for himself.

While each innovator would surely like to capture a much larger share than 2.2 percent, the robust forces of market competition oblige even the most successful of innovators to give the bulk of the benefits of their innovations to strangers in the form of price cuts, expanded outputs, and improved quality.

If the social benefits of the typical successful innovation were a pie divided into 45 equally sized slices, those who creatively figure out how to innovate, and who bear the risks of doing so in competitive markets, are content to allow those who play no role in the entrepreneurial-innovative process to grab 44 of the 45 slices. The persons responsible for making the pie in the first place ultimately receive as payment for their efforts only one slice.

That’s quite a bargain for humanity! It means that if, say, Jeff Bezos’s innovation is typical of those studied by Nordhaus (and there’s no reason to believe that on this front it isn’t), then Bezos alone is responsible for making his fellow human beings nearly $6.5 trillion dollars better off as a group. That’s about $840 of additional economic well-being for each and every man, woman, and child alive today on the face of the globe.

Because of Bezos’s efforts, you are $840 wealthier. So is your spouse. So is each of your children. So is your neighbor. So is your ne’er-do-well cousin Marty. (Actually, if you live in America, the amount of additional wealth that Bezos has bestowed on you is almost certainly greater than $840. The reason is that people who are most integrated into the global economy get a larger per-capita share of the benefits of market innovations than do people who are less integrated. The $840 figure is derived from dividing $6.5 trillion by 7.7 billion - today’s global population. But because the peoples of North Korea, Cuba, Turkmenistan, and other economically unfree countries enjoy very little, if any, advantages from market innovations, a more precise calculation of each Americans’ per-capita benefit would require that $6.5 trillion be divided by a number smaller than 7.7 billion. But we need not here do this calculation.)

A Parade of Benefactors

And yet Jeff Bezos is just one entrepreneur among a multitude. A handful of these entrepreneurs, like Bezos, are famous, but the vast majority are unknown. Do you know the name of the inventor of the shipping container that dramatically reduced the cost of shipping cargo? I’ll tell you: Malcom McLean - who, when he died in 2001, was worth $330 million. McLean, therefore, likely increased humanity’s collective well-being to the tune of about $15 billion, or by just about $2 for every person alive today.

Or have you heard of Janus Friis? He’s a high-school-dropout Danish entrepreneur who was critical to the development of Skype. Friis is now worth $1.3 billion - meaning that he likely enhanced humanity’s welfare by about $58.5 billion, or $7.60 per person.

Similar calculations can in principle be made for every entrepreneur who has ever succeeded in the modern market economy, from legendary titans such as Bezos and the late Steve Jobs to the far more numerous yet unknown - but as a group no less important - entrepreneurs who innovate in much smaller ways.

These latter innovators are unheralded. They include those who introduce tasty new fusion cuisines, figure out how to profitably reduce the cost of supplying automobile drivers with liability insurance, devise better methods of dry-cleaning clothes, and shave a few cents off of the per-mile cost of laying asphalt on street surfaces. The list of such examples is as long as is the list of innovations over the past two or three centuries. And each of these successful innovators, while in most cases personally becoming at least modestly wealthy, was obliged by the forces of market competition to give far more material wealth to others than each kept for himself or herself

It’s as if strangers routinely approach us and, asking nothing in return, hand to each of us a stash of cash. Bezos gave to each of us $840 (so far - he’s still innovating), and for each $840 he gave away he kept for himself only $19. Janus Friis forked over to every person $7.60, and kept for himself in each case $0.17. Malcolm McLean effectively slipped into every human being’s palm a $2 bill, each time keeping for himself a mere $0.04. And these are only three of millions of entrepreneurs.

Capitalism has Long Been the Ultimate Sharing Economy

The reality about innovation uncovered by William Nordhaus alone is sufficient proof that capitalism works magnificently. Of course, to say that capitalism works magnificently isn’t to say that it works without identifiable hitches, hiccups, and costs. But it is to say that those who today call for socialism to replace capitalism are ignorant not only of socialism’s well-documented history of failure and tyranny, but also of the enormous benefits that capitalism inspires in creative entrepreneurs to deliver daily, and with disproportionate generosity, to the masses

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Donald J. Boudreaux

Donald J. Boudreaux is a senior fellow with American Institute for Economic Research and with the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University; a Mercatus Center Board Member; and a professor of economics and former economics-department chair at George Mason University. He is the author of the books The Essential Hayek, Globalization, Hypocrites and Half-Wits, and his articles appear in such publications as the Wall Street Journal, New York Times, US News & World Report as well as numerous scholarly journals. He writes a blog called Cafe Hayek and a regular column on economics for the Pittsburgh Tribune-Review. Boudreaux earned a PhD in economics from Auburn University and a law degree from the University of Virginia.