Winner take-all economics

by on September 13, 2010 at 7:31 am in Economics | Permalink

Ezra Klein writes:

The top 1 percent, for instance, has gone from capturing about 8 percent of the
national income to 18 percent. But there's no obvious skills differential
between workers in the top 1 percent and the workers directly beneath them. It's
not like hedge fund managers are the only guys able to use Excel.

In a winner-take all economy, however, small differences in skills can mean large differences in returns and we have moved towards a winner take-all economy because technology has increased the size of the market that can be served by a single person or firm.  Sherwin Rosen laid this out in a 1981 classic, The Economics of Superstars and Robert Frank and Robin Cook have a good popular account, The Winner Take All Society.  Here is how I explained it a few years ago in a post titled Harry Potter and the Mystery of Inequality.

J.K. Rowling is the first author in the history of the world to earn a billion dollars
I do not disparage Rowling when I say that talent is not the
explanation for her monetary success.  Homer, Shakespeare and Tolkien
all earned much less.  Why?  Consider Homer, he told great stories but
he could earn no more in a night than say 50 people might pay for an
evening's entertainment.  Shakespeare did a little better.  The Globe theater could hold 3000 and unlike Homer, Shakespeare didn't have to be at the theater to earn.  Shakespeare's words were leveraged.

Tolkien's words were leveraged further. By selling books Tolkien
could sell to hundreds of thousands, even millions of buyers in a year
– more than have ever seen a Shakespeare play in 400 years.  And books
were cheaper to produce than actors which meant that Tolkien could earn
a greater share of the revenues than did Shakespeare (Shakespeare
incidentally also owned shares in the Globe.)

Rowling has the leverage of the book but also the movie, the video
game, and the toy.  And globalization, both economic and cultural,
means that Rowling's words, images, and products are translated,
transmitted and transported everywhere – this is the real magic of Ha-li Bo-te.

Rowling's success brings with it inequality. 
Time is limited and people want to read the same books that their
friends are reading so book publishing has a winner-take all
component.  Thus, greater leverage brings greater inequality.  The
average writer's income hasn't gone up much in the past thirty years
but today, for the first time ever, a handful of writers can be
multi-millionaires and even billionaires.  The top pulls away from the
median.   

The same forces that have generated greater
inequality in writing – the leveraging of intellect, the declining
importance of physical labor in the production of value, cultural and
economic globalization – are at work throughout the economy.  Thus, if
you really want to understand inequality today you must first
understand Harry Potter.

Hat tip to Matt Yglesias who understands the issue and points out how it applies to newspapers.

1 Just An Australian September 13, 2010 at 7:51 am

Thanks for this. So we return towards the income distribution inequity of the 19C (but far from it yet), and for primarily(?) technical reasons? But still, this represents a break in the social contract that has provided stability – I fear what the outcome will be in the future years

2 James Grimmelmann September 13, 2010 at 8:10 am
3 Lonely Libertarian September 13, 2010 at 8:13 am

But we are missing a BIG point – before JKR “discovered” Harry Potter she was on the dole – she came from the lowest quartile to the top 1% based on something SHE DID – not who she was or who she was born to…

Similar arguments apply to tech billionaires – Steve Jobs was adopted into a middle class family – and Bill Gates came from a well off – but far from wealthy family…

So the new world allows ANYONE to move into the top 1% – but they will do so based on the response of an unbiased market response…

4 ziel September 13, 2010 at 8:20 am

This makes sense, but Ezra’s basic premise that there’s no “obvious skill difference” is just plain silly. Anyone familiar with sports is well aware of the huge chasm in talent between major-league play and just the next rung down that feeds the majors. Just watch a Triple-A ball game – the difference is huge. It’s similar for hedge funds.

“It’s not like hedge fund managers are the only guys able to use Excel.” Could he possibly be that clueless? That’s pretty scary, quite frankly, that this guy is an influential writer.

5 Andrew September 13, 2010 at 8:27 am

Wait a second, oppression just recently took a big upswing? Not likely.

This is like looking at a 10-fold increase in autism over the past decade or so and having people tell you it’s genetics (AND diagnosis). It’s possible, but not likely.

The lefties need to update their priors to square their story.

6 baconisgood September 13, 2010 at 8:33 am

When you are discussing the difference between Rowling’s wealth and Homers you cannot leave out the protection from copyright. Homer would have made a lot more if no one else was allowed to reproduce his stories (I’m aware the CR protection would have belonged to someone else). Copyright has allowed Rowling to wait years between books without someone else writing a sequel for her, for her to wring the most out of the movie ‘rights’ and deprived consumers of thousands of variations on her theme.

7 Pat September 13, 2010 at 8:53 am

Klein’s comment makes him sound like quite ignorant of the skills it takes to run a hedge fun. I know Excel inside and out and would be a miserable failure running a hedge fund.

8 jhn September 13, 2010 at 9:05 am

I agree with the content of this post as applies to much of the economy, but I disagree that any differences of skill at all separate top hedge fund managers from the others. I attribute most of the success of top financial professionals to luck and connections, not skill.

As far as social mobility, we have less of it today than in the past 50 years, and less than most other rich countries. The US is closer to Latin America than Europe when it comes both to social mobility and to wealth distribution.

9 Bill September 13, 2010 at 9:16 am

Randomness should be rewarded. And handsomely.
Arbitrary initial states have unpredictable outcomes and can reward bigtime.

Just think about your own life and ask: What luck did I have in getting where I got–quite apart from skill levels.

And then be grateful, and not gloatful, attributing everything to your own effort.

Read Gladwell’s Tipping Point or his other book Outliers.
And, it is not just YOU and your effort: From the Wiki summary of Outliers:

“In Outliers, Gladwell interviews Gates, who says that unique access to a computer at a time when they were not commonplace helped him succeed. Without that access, Gladwell states that Gates would still be “a highly intelligent, driven, charming person and a successful professional”, but that he might not be worth US$50 billion.[3]”

“While Gladwell acknowledges his mother’s ambition and intelligence, he also points out opportunities offered to his parents that helped them live a life better than those of other slave descendants in the West Indies. Gladwell also explains that, in the 1700s, a white plantation owner in Jamaica bought a female slave and made her his mistress. This act inadvertently saved the slave and her offspring from a life of brutal servitude.[8] As one of the slave’s descendants, this turn of luck led to Gladwell’s relatively successful position in life. Summarizing the publication, Gladwell notes that success “is not exceptional or mysterious. It is grounded in a web of advantages and inheritances, some deserved, some not, some earned, some just plain lucky,”[8] and at the end of the book, he remarks, “Outliers wasn’t intended as autobiography. But you could read it as an extended apology for my success.”[2]”

By the way, Winner Take All analysis was popular in industrial organization econ about 15 years ago, and some thought it would be the ultimate defense of Microsoft. Haven’t seen much on WTA recently in the literature as an explanation (other than for high executive salaries, for which execs make this argument (you needed to pay me more to inspire the troops and I am the deserved outcome)), as the more common approach is today network economics and network systems.

10 Andrew September 13, 2010 at 9:38 am

Bill,

But the other side of the coin is the magic “10,000 hours” of practice that Gates was able to accrue on computers due to his “luck.”

And the real luck is in the nature of the network effect of the operating system business, but would we really rather that we took away some of Microsoft’s capital and handed it to Netscape in the name of social justice?

11 Trevindor September 13, 2010 at 9:49 am

For awhile I worked at a company that was the most successful in the world at what it did. Every time the media asked the founder for secret of his success he impatiently replied, “Right place right time, next question.”

He produced frozen french fries. He wasn’t the first or the last to try this as a business venture. He was one of the few to try it at a time that happened to slightly precede the fast food explosion. Those before him failed and those who followed him were (and still are) swallowed up.

Much like Gates and Buffett, this billionaire was keenly aware of the role luck played in his life. That notion, the ability to avoid the trap of the just-world fallacy, seems to be common to many billionaires.

12 BKarn September 13, 2010 at 9:58 am

“The US is closer to Latin America than Europe when it comes both to social mobility and to wealth distribution.”

Nicely parroted.

13 mark September 13, 2010 at 10:29 am

Klein is always at his worst when he addresses this issue. One simple question: how would he possibly know that the skills of the top 1% are not meaningfully different than those “below them”? There are quite a few 6’6″ basketball players but only one Kobe Bryant, to cite just one obvious example.

14 Yancey Ward September 13, 2010 at 10:36 am

It is difficult to believe that The Washington Post would pay Klein to write his columns when there are millions of English language writers on unemployment.

15 Bill September 13, 2010 at 10:41 am

Yancey, You make a good point, but also consider that Klein has established reputation on the platform, and there may have been an element of randomness in the initial selection. Now that he has an audience, the existence of other unemployed writers–many of whom are better than he is–may be irrelevant.

16 Bill September 13, 2010 at 10:57 am

Yancey, You might also argue that Klein competed to be on the platform, my only point being is the element of randomness.
A New York lawyer with whom I worked on antitrust matters was in a firm which represented a national newspaper. His son, while in highschool, got a job there, through connections and continued in the summer through college; the son went on to journalism/econ–and today works there as a very well-known business reporter.

I just think there is more randomness than most think, and I also believe that upper middle class parents with business connections often help their children get summer experience or the first job. That initial condition–your parents connections and their ability to assist their children–is random.

17 Andrew September 13, 2010 at 11:09 am

Bill, true, but randomness is rewarded. Not that it should or shouldn’t be. It is. It may be unfortunate, but to change it you have to intervene and you also have to get that just right to do no harm.

As for parentage, kids should help their parents. Especially my kids for whom I am doing a helluva lot of work to try provide the best brain development milieu I can.

18 Dan September 13, 2010 at 11:44 am

This is like looking at a 10-fold increase in autism over the past decade or so and having people tell you it’s genetics (AND diagnosis). It’s possible, but not likely.

Ooooh boy, we’ve got a “vaccines cause autism” loony here.

19 Jarda September 13, 2010 at 12:25 pm

It’s not like Ezra Klein is the only person who can write a blog… But here we go, he is cited in half of the U.S. blogosphere. And I am sure that if we measured the skills differential between him and the guys right below him, we would find a nice round zero.

20 Daran September 13, 2010 at 12:36 pm

One thing Erza does not mention is the size of the pie. The bottom 99% of the people probably prefer their 82% share of USA’s income over a system that would leave them with 92% of North Korea’s income.

Yglesias mentions the New York Times as an example, but their financial results are nothing to crow about. At the same time many websites and bloggers have managed to find a spot for themselves. (That is another effect of globalization: even the smallest niche can become sustainable by casting a wider net.)

In an open capitalist society, if someone makes above-the-norm profits people will seek to enter the market. In current times the consumer suffers less from cartels/monopolies, but more from rent-seeking through government regulations (by businesses as well as NGOs and labor unions).

Finally thanks to globalization the likes of Ms Rowling and John Kerry can use accountants to shift their income and taxes to the most advantageous location, while small businesses just breaking 250k are stuck and can be taxed to death.

21 njnnja September 13, 2010 at 12:56 pm

I have known successful hedge fund managers, and I have known hf managers who have blown up. Almost no one could tell a priori that the successful ones were the better ones, leading me to agree with c.f. Taleb’s argument that we are fooled by randomness. For those who still want to insist that the difference is talent, I would argue that it is a strange definition of talent that is indistinguishable from the lack thereof by the vast majority of onlookers, whether careful or careless.

But back on topic, I think that the jkr example can be generalized to not just a direct sales approach of a novelist selling a person a book, but to look at the whole economy as a network of all sorts of transactions. Power law type results arising from networks are not surprising; the only question is then how did the dynamics of the system change such that nodes with many edges have more than they would have under the old dynamics. There are lots of potential answers to this question, of course, but they do not fit in the margin of this comment…

22 Tom September 13, 2010 at 1:20 pm

“But still, this represents a break in the social contract that has provided stability – I fear what the outcome will be in the future years

Posted by: Just An Australian at Sep 13, 2010 7:51:07 AM”

I don’t remember signing any contract. Can you forward me a copy?

*****************
” Rowlings and the others you sited in your comment are the exceptions to the rule. If you don’t have some economic power and access, you’re still not going anywhere.

Posted by: Larry Jarvis at Sep 13, 2010 8:19:41 AM”

“80 percent of Americans worth at least $5 million grew up in middle-class or lesser households” : http://www.rd.com/home-garden/secrets-of-successful-entrepreneurs/article50301.html

How many exceptions are allowed before it is no longer a rule?

23 Chris T September 13, 2010 at 3:22 pm

By automating large portions of the economy, technology also allows much larger shares of income to be captured by a small group of people.

24 agnostic September 13, 2010 at 4:15 pm

Odd how eager economists are to appeal to non-linear reasoning when rationalizing growing inequality, yet when looking into the impact of the government driving more minorities into homeownership through e.g. the Community Reinvestment Act, everything is assumed to be linear — “the magnitudes just aren’t there,” and small differences cannot produce large effects.

25 dearieme September 13, 2010 at 6:28 pm

Senior executives get rich, on the whole, by looting the shareholders. They must, however, be jolly pleased to point at those people who get rich by properly economic activities, in hopes of presenting themselves as being equally deserving.

26 Martin September 13, 2010 at 6:48 pm

“Isn’t this the ideal outcome? J.K. Rowling, after all, was a single mom struggling to pay the rent.”

Except that if we assume you can’t just arbitrarily expand GDP and that the rewards to these individuals are growing faster than GDP (they are), then what you’re really arguing is that the rest of society is failing to earn a share that they would have been able to earn in previous generations.

Basically, you’re saying the ideal case is that it’s great if any individual can win the economic lottery even if it means that fewer others possibly can. Or, let’s expand the ideal case to its limit – and say that there can only be single-digit numbers of winners here, which we actually do see in some markets. Is that ideal? No matter who you are and how hard you work, only a handful of people will reap the rewards of the market? I’m not sure how comfortable most people would be with an ‘ideal’ where that extra 1% of talent, timing, or connections results in a 1000% increase in reward.

Athletes are a perfect example as the athletic market is not an open market – it’s a manipulated monopoly. There’s no ability to expand the number of quarterbacks in the NFL or shortstops in MLB. No matter how much talent pours into the marketplace or how much demand is available from fans, the number of available jobs is fixed and those that make the cut will be rich and those that don’t get nothing. Book/movie deals are more open, but they’re still limited by the number of contracts a limited number of publishers and studios are willing to write. Does anyone think that Harry Potter books 2-7 competed on an open field with the other authors? Rowland earned more money on those books than most authors make in a lifetime before she even wrote them. How can anyone claim that it was earned on merit in that case? The game was rigged in her favor because it favored the publisher to keep a franchise going. Nobody else was going to get a book in that narrow genre published no matter how good it was.

27 Bernard Guerrero September 13, 2010 at 7:17 pm

“Nobody else was going to get a book in that narrow genre published no matter how good it was.”

Wait, what? http://www.amazon.com/s/ref=nb_sb_ss_i_0_7?url=search-alias%3Dstripbooks&field-keywords=fantasy+books&sprefix=fantasy

I can’t claim that I’m a huge fan, but clearly the particular first book that she put out was good enough for the target audience to generate popularity, which led to network effects (via every kid wanting to be in on the experience), which led to etc, etc. And if 2-7 had been completely awful as compared to the first, then no amount of marketing from scholastic would have kept the kids reading the stuff.

28 bel September 13, 2010 at 11:06 pm

Tolkien lost his opportunity because , Rawling was born too late. His book were made into movies only after the Pottermania
The same can be said of Ruth and A- Rod. By the way in $ of 2010 how much did Shakespeare earn?

29 Vehicle Driver September 14, 2010 at 12:45 am

The trouble people here are having, is they are making a moral argument about why “winner takes all” justifies a higher tax on the rich.

It doesn’t matter if the rich “deserve” to be taxed or not if your goal is to maximize revenues to fund the welfare state. Tax rate != tax revenues. The fact that no one who advocates higher taxes for the rich even bothered to consider if such a plan maximizes tax revenue, makes me highly skeptical that your ideas are anything beyond class-resentment.

30 Harald K September 14, 2010 at 4:41 am

Tabarrok,

Your old comment on J.K. Rowling’s success is spot on. I just want to know: You speak of small differences of skill having a large impact. But do you think this is the case with J.K. Rowling? In other words, that she was ever so slightly better than all the other hard-pressed single moms who tried to get fiction published?

I can’t see that there’s reason to think that (although I did enjoy her books very much). Small differences of fortune get magnified out of all proportion, too. It is more likely, I think. I don’t think that success is a good measure of relative skills in art at all. Not even in particular fields, or for critical success as opposed to financial, can I say it predicts skill very accurately.

31 Andrew September 14, 2010 at 8:16 am

Ziel, did you read them?

The one about forklifts versus microphones might be the most important thing I learn this weak, if not this year, and not just from a blog!

Not that I didn’t already have that as an inkling, being a big follower of Buffett, but the analogy is enlightening.

32 Ankur September 14, 2010 at 1:21 pm

Will it be right to say that “Improvements in Technology have led to Inequality”

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34 downline October 2, 2010 at 12:28 am

The rich gets even more richer while the poor becomes even more poorer. I think that it would indeed be a very good thing to have the best of the things. The marketing filed one such field that works a little against this law. The one with a better thinking and knowledge of the market can make it big and this one applies in case of network marketing.

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