FREE GROWTH AND OTHER SURPRISES
Draft
Gordon Getty
FOREWORD BY THE AUTHOR
How Come This Book?
A few months ago, Robert Trivers was kind enough to send me his new book. The
title is “Wild Life”. Perfect two ways. Bob is a world authority on wildlife, to wit
evolutionary biology. But his books and papers about that are already well known.
His new one is about his own wild life, with his ideas in the background.
I’ve started my own book three for four times over the past decade. Bob’s got me
started again. Try it. It’s Bob’s real voice. One of his papers, co-authored by Huey
Newton(!), is about deception and self-deception. I never saw much of either in Bob.
I never saw a guy less anxious to impress. Fine if you knew his achievements, and
fine if you didn’t. What he wanted to talk about was great new ideas by others. It
was from him that I first heard about the Hamilton-Zuk parasite theory, and Paul
Ewald’s complementary one about parasites stabilizing population density of hosts.
Both are beautiful examples of the obvious-in-hindsight.
I realized that my book could take a cue from his. My own life hasn’t been wild. It
has been interesting because the genius of my father gave me interesting places to
be and things to do. I could say something about that.
But the book would be mostly about my ideas in economics. Bob’s ideas are well
known to anyone in his field. Mine aren’t. I’m ten years older than Bob, without
much to show for it except in composition. (My last two operas have been getting
some traction, and my SACDs get pretty good radio time.) So I’ll run my economic
ideas up the flagpole, in my real voice, and see if they prove deception or selfdeception
or something worth the time.
Declaring My Biases
I’m a big free market fan. I would love it even if I agreed with socialists that there is
something inherently iniquitous about it. There are bad guys and conflicted motives
Forward By The Author 04/18/16 1
in markets and government both. What I love about it is the chance to prove ideas. I
love Wall Street innovations such as swaps and futures and ETFs and mortgagebacked
securities, even admitting their dangers. And who would have thought that
the San Francisco Bay area, a stronghold of political correctness at the voters’ booth,
would nonetheless innovate Siri and Alexa and driverless cars, in its free market
havens here and there, over the past five years? Remind me the last innovation by a
committee. Who would have thought we would make the world’s best car, the Tesla,
in this labor stronghold? It takes guys who prefer the impossible. It takes guys like
my father.
Yes, that was J. Paul Getty. I’ll declare a bias for him. His faults were just what we
read they were. I liked them fine. My times with him, with an exception I’ll note in
Chapter 1, are some of my favorite memories. I seem to be the opposite of pharaohs
who began their reigns by chiseling off their father’s names from the monuments
and substituting their own. That was something about a ticket to the afterlife. I put
my father’s name on things I build. The afterlife will come as it comes.
Since this book is about growth first, I should say how I feel about growth. Most
economists, which I’m anything but, treat it as a goal. I love innovation, which has
translated to growth, while worrying plenty about growth itself. What happens
when anyone can make a doomsday weapon on his desktop? Depressed people do
away with themselves every day. Some might take the rest of the world with them if
they could. Armageddonist religions wouldn’t be needed. Not even destructive
intentions need be. A doomsday weapon bought at the five and ten might go off by
accident.
Then why do I root for innovation when I’m scared stiff about its consequences?
Because alternatives are scarier still. Humans will innovate anyhow, while Big
Brother or the religious authorities aren’t looking, and I don’t like the prospects of
innovation driven underground. We’ll have to find some way to face the risks and
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manage them. This book doesn’t say how. It will open that can of worms, and others
too, and try to track some but not all to their destinations. One look leads to another.
This shows that I’m not an optimist in the sense of making rosy predictions. But I
seem to show that bias in evaluations. I’m two thirds Panglossian. (Doctor Pangloss
was the guy in Voltaire’s Candide who said that this is the best of all possible
worlds.) I side with the good doctor in that I cannot imagine an improvement to this
world or to the human race. I see the dangers and evils, such as Armageddonists, as
somehow part of the scheme. The world would not be better if it posed no threats
and challenges to solve. To solve them is not to wish them away. The stories of
Aladdin’s lamp and the monkey’s paw tell us that each wish after the first is to undo
the one before. I think that’s what Shaw was telling us in Don Juan in Hell. Don Juan
and the others are free to go to heaven whenever they like, and occasionally do.
They come back because they can’t stand the boredom.
Where I find fault, and differ with Pangloss, is as to the doctrines we are taught.
Whatever I study, I seem to find a good measure of nonsense taught along with
wisdom. This book is about what I find of both in economics. And a problem I try to
solve, not wish away, is the danger of losing sight of the points on which Pangloss
was right. My verse and music try to remind us.
And I’ll admit a bias for the surprises my title promises. I love upending what we
had all assumed. Fun! And all the more fun when I can show that famous economists
had already seen and said some of the same things I do when we read those
economists again. Surprise need not be true novelty. My free growth theory is really
John Stuart Mill’s, although no one seems to have noticed the paragraph I quote
from him. My next generation theory really belongs to my 17 th -century rhymesake
Sir WilliamPetty, who happens to be my nominee for greatest economist of all time.
In a way, I could also credit it to the period of production theorists John Rae, Nassau
Senior, William Stanley Jevons and Eugen von Boehm Bawerk. They need only to
have considered human and total capital as explained by Petty two centuries before.
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This reveals my bias for economic history. It seems dry as a bone until you find
something terrific like those insights. It happens that I had written both theories,
and published one, decades before I found those great precedents. Should I have
been chagrined? Of course not. Forgotten or unnoticed precedents are at least as
much fun to point out as the surprises they showed ahead of me.
I will also reveal a bias for evolutionary biology. Its main axiom, the biological
imperative, becomes one of mine. The idea is that behaviors are selected for
successful reproduction. I will try to show that the classical school treated this as
axiomatic from Petty through Smith, Malthus, Ricardo and Mill. Malthus was only
the most obvious case. It lapsed from attention when a brilliant new insight called
marginalism preferred to do without explanations for tastes.
Above all comes my bias for the great thinkers in those fields. We saw that as to Bob
Trivers. Although I often cite them to disagree with them, I see all as giants from
whose shoulders I slip in trying to climb. I don’t kick sand on 97-pound weaklings.
Mill was a mensch who gives us all lessons in attribution and generosity, particularly
to schools he disputed, and who nonetheless didn’t mind being a minority of one in
his books or in parliament.
Petty was something beyond. Polymath, self-made tycoon, anatomist, music teacher,
father of national accounts, originator of present value theory and human capital
and next generation theory, and esteemed by both Adam Smith and Karl Marx for
other innovations I don’t mention. Such men are understood slowly and
incompletely.
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CHAPTER 1: RECOLLECTIONS
I never finished a course in economics. I started one at the University of San
Francisco sixty years ago, and dropped it when I couldn’t see the foundations. But
the bug had bitten me. I knew that one day I would try on my own.
I always loved logic. My favorite philosophers at USF were the pre-Socratics who
liked nothing better than to confound common sense. A brilliantly vexing example
was Zeno the Eleatic and his argument that Achilles can never catch up to the
tortoise; Achilles must first reach the line where the tortoise was last, and the
tortoise has since moved on. Logic can play such tricks. But I sensed that economics
was the place to try its limits. Dropping the course didn’t mean giving up, and logic
would be the key.
Neither did I take a course in business administration or investment. My major was
English literature. As a grade schooler I had asked my father about this. Where and
what should I end up studying? He had read economics and petroleum geology at
Oxford, and I supposed he would advise something like that for me. I got a surprise.
Career-oriented majors were fine but not necessary. A grounding in the liberal arts
could be as much or more. The trick was to learn how to learn. That sounded right,
and anyhow right for me. So I chose USF, a twenty-minute walk from home until my
mother moved us to San Rafael, a half hour drive across the Golden Gate Bridge, and
followed my intuitions toward English lit and history and music and philosophy.
I graduated with a degree in English lit in 1956. This was the time of skittish peace
between the Korean and Vietnam wars, and the Reserve Forces Act meant I had to
report for six months active duty starting in the spring of 57. Meanwhile I worked
for my father. I and my brother Paul, later Sir Paul, started at the bottom pumping
gas and changing oil at separate gas stations not far from our home in San Rafael.
That left time for a few weeks at a bulk plant (oil warehouse and tank farm) in San
Francisco, still working at the bottom, before I reported. Paul had served in the
Chapter 1: Recollections 1/06/16 1
Korean war, and was now exempt. I was a shavetail second lieutenant, thanks to the
ROTC program at USF, in the quartermaster branch at Fort Lee, Virginia. My
eyesight was never good enough for the combat branches.
Ike, who was then president, had started in the quartermaster too. My military
career was not so glorious. Somehow I finished the six months at Fort Lee and seven
and half years of inactive duty following, obligating me to one weekend per month
at military posts near home, without being promoted even to first lieutenant. By
policy, I should have been promoted or busted to the ranks. I later learned that my
school chum Manuel Teles, who worked at Fort Presidio in San Francisco, had
somehow fixed the record. Thank God for old friends.
My weekends of saluting were postponed when Paul and I went back to work for my
father in 1958. My father then lived in the Ritz Hotel in Paris. He liked ordinary tworoom
suites. The sitting room was his office. His filing system was a steamer trunk.
Our job was to sit and listen as he met with executives or art people or old friends.
He would usually take us along to lunch and dinner, and wangle us along when he
had been invited out. He was the world’s most attentive father whenever we were
with him, at least, if focused elsewhere when we weren’t.
Paul went on to learn refining and marketing in Italy, after those few weeks in Paris,
while I went to the oilfields my father had just found and developed in the Neutral
Zone between Saudi Arabia and Kuwait. Paul soon learned Italian, became general
manager within two years, and ran things well. I learned only a little Arabic, but also
became manager in 1959, and soon blundered my way into two weeks’ house arrest.
I had got crossways with the local emir, Mohammed bin Nasr, not a bad guy, about
perks and privileges he and his staff expected Getty Oil to pay for.
The case against me was rigged. One of our junior staff drivers, a Kuwaiti I think,
had accidentally rammed and damaged a pipeline. He had fled the country to avoid
jail. Jails there were no fun. His supervisor, Jim Kinnell, was warned that he (Jim)
was accountable under Saudi law, and would be sent to jail instead. Jim came to me.
I realized what was brewing. Laws are flexible, and Jim would have got off with a
Chapter 1: Recollections 1/06/16 2
caution at most if I weren’t at odds with the governor. I was obviously next. But I
was not about to gamble that the threat to Jim was a bluff. I told him that if I were in
his shoes, I would go back to England. He did. That left me. But I was in my shoes.
The blunders had been mine, and I would face the music.
My two weeks of house arrest went peacefully. The plain cement-block house had
been built for my father at our port camp of Mina Saud when he lived in the Neutral
Zone in 1953. The Emir’s identical house was a few steps away. My father’s favorite
maple sugar was still in the fridge. I read the few Shakespeare plays I hadn’t read in
college, and read or reread the complete poems and plays of John Keats.
The house arrest was probably as much dressing-down as I deserved. Paul, or
anyone else, would have handled the perks and privileges more adroitly. But our
host country, Saudi Arabia, may have picked up on something too. Getty Oil was not
one of the concession companies in the Middle East named in the baksheesh
(bribery) scandals that made the front pages over the few years remaining before
most concessions were negotiated away and host countries ran things themselves.
Back to my father in Scotland, where he was visiting his old friends the Maxwells
near Inverness, and then to the two-room suite at the Ritz in London about like the
one in Paris. He drove the six hundred miles between, in a vintage Cadillac, taking
two days and stopping to visit historic sites and museums. He needed no guidebook.
I sat in on meetings and events everywhere with him in London as in Paris. I
assumed that the Saudis had cleared the house arrest with him, and I would have
agreed as he did. He too was in different shoes. He was right. He had solved a real
problem with minimum damage. Lesson learned, and no hard feelings either way.
It was clear to both of us that I was not cut out to be a line officer, meaning one who
runs things from day to day. My mind goes off on tangents instead of tracking
arguments in real time. It works for me, but not as an administrator. We decided to
try me as a consultant.
Chapter 1: Recollections 1/06/16 3
That began at my father’s Spartan Aircraft Company in Tulsa, Oklahoma. He hadn’t
meant to buy it. He had bought control of Skelly Oil, centered in Tulsa, and Spartan
turned out to be one of its holdings. Then came Pearl Harbor. My father was 48
years old, and had been a yachtsman. He took a navigation course at USC along with
kids half his age, led the class, and volunteered for sea duty. His old friend James
Forrestal, Secretary of the Navy, steered him to Spartan instead. Spartan could make
training planes and could train pilots. My father accepted. He paid himself a salary of
one dollar a year.
He had decisions to make when MacArthur and Matzushita signed the peace treaty.
The training planes were not meant to leave the ground. Spartan lacked the
capacity to make the real thing up to competition. The demand for training planes
pretty much ended with the war. My father could sell out or find another use. He
decided to make house trailers. It worked. I had lived in a Spartan trailer in the
Neutral Zone, like the rest of the senior staff, when I stayed at our Wafra oil field
rather than the house at Mina Saud. We and the market had liked them fine.
Herschel Shelton had been one of my father’s right-hand men during the conversion
to trailers. He said that the place to look for him was never in his office. You would
find him in overalls under a trailer on the factory floor, with a welding iron or
riveting gun. He liked to be able to do any job his workers did. How else would he
know if they were doing it right?
I stayed in my father’s house at Spartan, as at Mina Saud. It stood at the opposite end
of the runway from the offices and trailer plant. I drove another seasoned Cadillac
that my father had left in case he came back. Max Balfour, who ran Spartan, called it
a clunker. It clunked me around the countryside on weekends, or to Jamil’s
restaurant or Cap Balfour’s house for dinner, or downtown to the movies or
symphony or opera house. Cap (Captain) Balfour had flown in World War I, and
showed crippled hands from when his plane caught fire. He was cranky, urbane and
razor-sharp. His problem was that Spartan couldn’t seem to come out in the black.
He worshipped my father, and figured he had let him down. He seems to have
Chapter 1: Recollections 1/06/16 4
brought his moods with him after work, which my father generally didn’t. That cost
him his sunny young wife. I somehow got a pass. I could understand him, and I was
my father’s son.
My advice in the end was that my father should sell. Meanwhile I was taking an
interest in economics again. Business was about rate of return. Spartan’s was
negative. What was the benchmark? I did a little study.
It is easy to see that return tends to even out from one company or industry to the
next. We pour investment into high-return prospects, and unintentionally drive that
high return down toward the norm by expanding the capital denominator. I didn’t
know that Robert Turgot had written the same in 1766. But what struck me was the
impression that return, net of inflation, seemed to revert to a norm over time. Why
were interest rates, averaged over business cycles, about the same then as in
Dante’s time or Julius Ceasar’s? Why should human impatience be a steady norm?
That puzzle nagged me for about a quarter century until I found the answer.
Another decade or two would pass before I learned that Sir William Petty had found
it in the seventeenth century.
I went home in 1961 to study harmony and counterpoint at the San Francisco
Conservatory of Music. I had found time to compose a few things at the house at
Mina Saud with a piano I had bought in Kuwait. They included an a cappella
(unaccompanied) choral setting of Tennyson’s “All Along the Valley”, and something
to which I later fit Emily Dickenson’s poem “Beauty Crowds Me” in my song cycle
“The White Election”. The composer Charles Haubiel published “All Along the Valley”
in his Composers’ Press in Los Angeles in 1959. The one change he suggested, an
unexpected D flat major resolution, is the best touch in the piece. I had noticed
copies in music shops in Tulsa. So it seemed about time to develop that interest too,
and the conservatory back home seemed the logical place.
Chapter 1: Recollections 1/06/16 5
I studied there from fall 1961 through spring 1962. I was probably the only
composition student already published. My teacher in both the fall and spring
classes was Sol Joseph. He was a legend there. Most of what he taught confirmed my
instincts. Maybe five percent was old rules I didn’t think much of, and five percent
good ideas that hadn’t occurred to me. All was useful anyhow as a guide to what
leading authorities have thought and taught. That was the point. We were to accept
what we liked, and anyhow learn the lingo.
Those two courses covered traditions of the eighteenth and nineteenth centuries.
Most composers in the 1960s, and probably some or most of my classmates, thought
of that as a stepping stone toward study of the serialism and other atonalism then in
vogue. I skipped those classes. I realized that I was a nineteenth-century composer
at heart. Now the world seems to have spun back to where I was all along. For most
composers now, atonalism is one of the colors on our palettes. Even I use some. So
did Bach. We reach for that color when we want to express disorientation or angst. I
found I could get more said most of the time with major-minor scales.
Five short piano pieces I wrote then were published by Belwin Mills in 1964. As my
father’s son, you might imagine that I was asked to pay the costs. Nope. Neither had I
paid a cent to Composers’ Press. Vanity press exists, but that was not the business
model of those two firms. I got standard royalties from sales, not amounting to much,
and they got the rest.
Six published pieces by age 31 would not have impressed Mozart or Schubert. By
lesser standards, it was a pretty good start. There are distinguished composers who
have never found a publisher. Tomorrow the world! I would write operas and
symphonies! What happened instead was sixteen years of writer’s block, or eighteen
since finishing the pieces in 1962. I suppose I was trying to say “Shazam!” and turn
into something I wasn’t. The ice would break in 1980, when I realized that Billy
Batson would have to do. But that gets me ahead of my story.
I married Ann in 1964, making it a banner year on that count even more than the
publication, and went back to work for my father. That took us to New York in 1965.
Chapter 1: Recollections 1/06/16 6
Tidewater Oil Company, which would merge into its parent Getty Oil Company a few
years later, had red ink problems in its Eastern Division. My job was to see why.
Eastern Division was run by “Jim” Jiminez, an upbeat guy I liked. I don’t think he
took the red-ink problems home with him as Cap Balfour had. He reported to my
half-brother George at corporate headquarters in Los Angeles, and George reported
to my father in London. George had earned his job as president by outstanding
performance at every level on the way up, which is more than you could say for me
in the Neutral Zone. But George was touchy. He had a chip on his shoulder. I think
my father liked to ride him, and he sometimes felt unappreciated. You have to shrug
that off. George was doing fine. The problem in Eastern Division was not in him, and
it was not in Jim Jiminez. Then what?
I looked at the books. The red ink had nothing to do with management. Eastern
Division did refining and marketing. Its new refinery in Delaware had been
optimized to process heavy Wafra crude oil, which then was over a dollar cheaper
per barrel on the market than the lighter and easier-to-refine crude we produced in
Texas and the Central Basin. Tidewater’s Western Division refinery at Martinez, by
contrast, had all the cheap oil it needed in our own San Joaquin field. The Martinez
refinery was old, and more expensive to operate. But the net advantage still went to
Western Division by about a dollar per barrel. Meanwhile gasoline sold for about a
dollar less per barrel, although only two or three cents less per gallon, in the
refinery-loaded east than in California.
Management can’t do much about import quotas and market conditions. I reported
to my father that Eastern Division was at least as well run as Western Division,
where the ink was black thanks to cheaper crude and pricier gasoline.
Then could we cut costs or boost receipts in other ways? I proposed that we close
our old and inefficient Boston Harbor terminal, where barges unloaded gasoline into
our tank farms to be trucked to stations, and supply Boston from our new terminal
at Providence two hours’ drive away. If that worked, other distribution
consolidations seemed possible. I later proposed much the same thing for our
Chapter 1: Recollections 1/06/16 7
operations in Japan, where the new terminal at Kawasaki could theoretically obviate
the older and clumsier one in Tokyo Harbor. I realized that plant-closing might be
unthinkable in Japan, but thought that something good might come of the idea.
Sometime a little later came my lawsuit against my father. It isn’t my happiest
memory. There had been a stock dividend years before, when I was still in school.
We had treated it a certain way on the books. I read the law as saying it should have
been treated another way. The law was probably on my side, and common sense on
my father’s. Judge Peery wisely found a way to make common sense win in the end.
Meanwhile I had accused my father of nothing worse than oversight. My visits to
Sutton Place, now with Ann and the boys, went the same as before. The lawsuit
seldom came up and was discussed in easy terms when it did. I suggested to him, for
example, that he might want to settle with my stepmother Teddy in case there could
be claims by the estate of my late half-brother Timmy. He did. Somehow we got
through the lawsuit without bad blood. One would not have guessed so much was at
stake. The stock dividend had been a huge one. What I learned from my father, then
most of all, was perspective. He believed in an even keel. Zeno the Stoic, not the
Eleatic, would have met his match.
The lawsuit lasted from 1966 through 1971. In hindsight, thank gosh he won. If I
had, tax consequences would have been ugly all around. Again I had learned a lesson,
and again there were no hard feelings either way.
I continued to do consulting jobs for him throughout the lawsuit and after. I charged
expenses, but no fee. And I didn’t pad expenses. If I had, you can believe he would
have seen it. I stayed in a single room in the best hotels, ate three squares a day, and
paid for anything else myself. I was trying to make the point that I didn’t want to be
paid. Neither had my father at Spartan during the war. The idea was for me to be of
use. I was paid like everyone else when working for my father full-time, but never
on consulting jobs.
Those now came once or twice a year, and lasted for a week or two each. Composing
was still on the back burner. I was keen on physics, economics, human origins and
Chapter 1: Recollections 1/06/16 8
city planning. It became clear that all but the third needed better math skills than I
had. So I bought the Barnes and Noble textbook on College Mathematics, got through
it in a week of hard work, and then began on the Johnson and Kiokemeister textbook
on calculus along with Halliday and Resnick on physics. Together they took me
nearly a year. At the end, I was allowed to sit in on the freshman physics finals at Cal
Berkeley, where the same two textbooks were taught.
It was the finals for physics majors, and meant to be tough. Cal took physics
seriously. Not every freshman was destined to go farther. Some should be steered
towards engineering, which pays better anyhow. There were 10 questions. Three
hours were allowed. Each of us had a calculator and nothing else. Not even a table of
integrals. My God. I had to remember them or rederive them. There are some that
had taken even Newton and Leibnitz months to solve. I don’t remember any of the
questions. There were 200 to 300 kids in the room. Maybe 20 or 30 orientals, about
three women, no blacks. Not one finished early. And some figure to be Nobelists by
now. We’re talking about Cal. I had answered seven questions when the three hours
were up. Was that good enough? I got a call in a few days. I passed, and beat the
class average.
My old friend Matt Kelly warned me about this time that George was in trouble. Matt
had known George’s new wife Jackie, and had been invited to dinner there. Matt’s
impression was of out-of-control mood changes. He said that George at one point
had drawn him aside, shown a pistol and warned him about paying too much
attention to Jackie. The next minute they were back at the table in jolly spirits. I
learned later what was wrong. George thought he had a weight problem, although I
never noticed one. Doctors prescribed amphetamines in those days to control
appetite. They revved him up and made it hard to sleep at night. So the same doctors
prescribed barbiturates at night to get him to sleep. Uppers and downers are
dangerous enough. Add a drink or two and you’ve got trouble.
Of course I should have told my father. But I didn’t want to be the one. I liked to
boost my brothers. Many must have seen the symptoms Matt saw. Let them break
Chapter 1: Recollections 1/06/16 9
the news. But the others must have felt as I did. We waited too long. I got a phone
call in 1973. George had died at Mount Sinai Hospital. There was an empty bottle of
sleeping pills.
My father’s death came in 1976. Ann and I had got word it was coming a few weeks
before. We were there. So was Norris Bramblett, an accountant who had worked for
my father since I was in school. My father trusted him. So did I. He had only a fourth
grade education, but a PHD’s worth of character and sense. My father, Zeno the Stoic
when things got tough, cracked jokes to the end. Norris alone could understand him
by then. He translated patiently. My father was giving me one more lesson. He
lapsed into a coma. Ann and I were called down from our bedroom when he died.
That left me and Lansing Hays co-trustees of the trust controlling his companies.
Lansing ran the law firm that handled nearly all my father’s business and little else.
It was a big job. Lansing was smart, abrasive, and dead honest. He didn’t mind
hurting people’s feelings. I was not immune. It didn’t matter. It wouldn’t have
mattered to my father. What mattered was that Lansing knew what trust meant, and
put the Trust first. That’s what I cared about.
Lansing was already on the Getty Oil board. I was invited to join too. We met four
times a year, most often in Los Angeles. Harold Berg, an oil engineer from Colorado,
had become CEO (chief executive officer) and chairman after George died. Sid
Petersen, an accountant, was COO (chief operating officer). Harold was a warmer
and more approachable personality. That’s what you’d expect in an oilfield guy. Sid
was reserved and analytical. That’s what you might expect from an accountant,
although Norris Bramblett fit anything but the stereotype. Harold and Sid were both
clearly well chosen. Neither then nor later did I doubt that Getty was run at least as
well as its big oil rivals.
The board too were top people. But trouble was brewing. The trust, meaning
Lansing and I, owned about 43% of the shares. The Getty Museum, also chaired by
Harold, owned another 11%. Boards and managers prefer scattered ownership, so
that they can operate more freely. Second-best would be concentration in docile
Chapter 1: Recollections 1/06/16 10
hands happy to follow the board’s guidance. But my father had made it clear to
Lansing and me that we were to trust our judgment. We should be ready “to vote the
management in and out.” Since stockholders elect boards and boards hire managers,
that meant to vote the board in and out.
No wonder they were concerned. Lansing and I were both boat-rockers. Wouldn’t it
be safer if there were a corporate co-trustee? These are usually safety-minded banks,
and many banks did business with Getty Oil.
Concerns rose when Lansing died in 1972. That left me as the sole trustee. I was less
obstreperous than Lansing, but also less predictable. Hostile takeovers were
common then, where bids are made directly to shareholders rather than cleared
through the board. Getty was rich in oil reserves per dollar of share price. It could be
a target. Board members tend to feel that they know stockholders’ interests best,
and that the angels are on the side of “friendly” or board-approved takeovers if any
at all. Stockholders don’t necessarily feel that way.
Temperatures rose when I pushed serious study of the possibility of taking Getty
private. The idea was to give up our corporate structure to escape the corporate
double tax. Management and its investment banker, Goldman Sachs, advised against.
I now think they were right, although my idea had good precedents. I pressed on,
unwisely, by trying to convince the Museum to back me. They had better sense.
It was time to heal the breach. Marty Lipton of Wachtell, Lipton, a top mergers and
acquisitions law firm, represented the Museum. He proposed a moratorium (the
“tripartite agreement”) where the Trust, Museum and company would hold the
status quo for one year. Harold Berg had retired as chairman of Getty Oil, and Sid
was now chairman and CEO. His COO was Bob Miller, a keen petroleum engineer.
Harold Berg still chaired the Museum, although Harold Williams was its CEO and
main voice. We all signed. But Getty Oil had its fingers crossed. A few days later, the
company petitioned the court to appoint a co-trustee. It proposed Bank of America.
B of A’s chairman, Chauncey Medberry, sat on the Getty Oil board. Paul and George’s
daughters joined the plaintiffs.
Chapter 1: Recollections 1/06/16 11
The Museum was more outraged than I was. Marty felt that he had been used. He
and Harold Williams, a business-savvy guy who had chaired the SEC under Jimmy
Carter, realized that if I could be hog-tied, the Museum with its 11% was the next
domino.
This was in November of 1983. Within a few weeks, the Museum and I signed a
“consent of shareholders” taking over the company. The required public disclosure
of this, on top of the tripartite agreement and co-trustee lawsuit before, was blood in
the water.
Pennzoil launched a hostile takeover bid in December. My concern was that the
trust should not be locked in a minority position. I met with Pennzoil in New York.
We resolved that to my satisfaction. The Getty Oil board met, also in New York, on
January fourth. The mood was not sunny. Harold Stuart, one of the brightest and
finest board members, assumed that I had invited the Pennzoil bid. Chauncey
Medberry thought I should be sued. But Sid and the board acted responsibly overall.
We countered with a higher price, Pennzoil accepted, and we went home thinking
we had a deal.
Texaco offered a higher bid two days later. Was Getty Oil already bound to Pennzoil?
Its lawyers and mine said it wasn’t until the final agreement was signed. I had my
doubts. But I liked Texaco’s offer better, and my duty was clear. The Trust and
Museum would be paid cash for their shares, rather than locked in. I had insisted on
language in the Pennzoil agreement that bound me only as “consistent with my
fiduciary duty.” My duty, in the light of legal advice, was to accept Texaco’s offer. I
did, and voted the same way as a member of Getty’s and the Museum’s board. Those
were fiduciary duties too.
Pennzoil sued Texaco, and eventually won punitive damages of some eleven billion
dollars. The Museum and Trust had cashed out. We were not parties. The Pennzoil
and Texaco filings both spoke well of me. But there was still the lawsuit seeking a
corporate co-trustee. That would have been very dangerous before the sale to
Texaco cashed us out. A corporate co-trustee might well have assented to “corporate
Chapter 1: Recollections 1/06/16 12
defenses” blocking a sale and effectively locking the trust in a minority position. But
now that danger was over. The remaining plaintiffs were my three nieces and Paul. I
couldn’t blame them. How could a corporate co-trustee hurt?
But I was still worried. I now wanted to split up the trust into four separate ones for
my family, Paul’s, George’s, and my other half-brother Ronnie’s. Corporate cotrustees
tend to prefer the safety of acting only as required, and anyhow might not
be keen to vote themselves out of a job.
Were Paul and my nieces mad at me? Believe it. Lawsuits get that way. Lawyers on
both sides say nasty things. That lasted because splitting the Trust took time. The
math was easy, but the legal precedents were vague. My lawyer, Mose Lasky,
thought we needed new California law. Plaintiff’s counsel didn’t think so. I was
accused of stalling. Someone had the bright idea to approach Willy Brown as
Speaker of the Senate. The law Mose wanted had already worked in other states,
and Willy liked it. He pushed it through. Problem solved. The Trust was split into
four in 1988, and an unhappy chapter ended. My nieces and I are as close as ever. So
were Paul and I until his death in 2002.
My interests by the time of the split were composing, verse, economics, human
origins and evolutionary biology. Composing was going pretty well. My writer’s
block had melted away in the summer of 1980. Ann and I and the boys were in Paris
then. We wandered into Smith’s English language bookstore. I bought the Thomas
Johnson variorum of Emily Dickenson’s 1800-odd poems. “Variorum” means
including Emily’s own variations when she mailed the same poem to different
people, or put a copy in the chest at the foot of her bed.
I read them all over the next two days. Emily had been one of my favorites at USF.
She died in 1886. She had published only eleven poems. Squabbles among the heirs
delayed publication of about half the rest until Johnson published them in 1959,
three years after I graduated. Many already published had been “bowdlerized” to fit
conventional rhyme and grammar. Johnson gave us the real McCoy from her
manuscripts. All was new to me.
Chapter 1: Recollections 1/06/16 13
I had no piano in our hotel room in Paris, but set a few of the poems in my head to
write down later. More followed. One of her poems I didn’t set begins “Mine by the
right of the white election…” Election meant choice. Her white smock hangs today by
her bed in Amherst where she was born and died. White is the color of weddings
and burials. Her choice, I think, was a death marriage to the reverend Charles
Wadsworth of the Arch Street Church in Philadelphia. He was happily married. She
met him about three times in her life. I would tell her story in 31 of her poems, one
in two different settings, in my cycle “The White Election.”
It was completed in 1981, and broadcast on National Public Radio two years later. It
seems to have made a good impression. Slava Rostropovich had kind words, and
invited me to write something for cello and orchestra that he could schedule on his
upcoming tour in Russia. Placido Domingo invited me to write a song for him.
Renata Scotto wanted me to choose five or so of the White Election songs that she
could include in her concerts. All were big opportunities. Somehow none happened.
Other stuff was coming out the pipeline.
That included my opera “Plump Jack.” Here I would tell the rise and fall of Falstaff in
Shakespeare’s Henry the Fourth and Fifth. This was riskier. Now the
accompaniment would be orchestra, not piano, and I had no background in
orchestration. Composing and orchestrating are not the same. Composing is like
writing a play, and orchestration is like casting the play. There are composers that
don’t orchestrate, and orchestrators who don’t compose. Most of us do both. I
always did my own orchestration because no one else would know what I wanted. I
gradually learned from my mistakes. Now I can probably hold my own in
orchestration, although many do that better.
Plump Jack was completed scene by scene over some twenty years. I would think it
was finished, and then decide it wasn’t. My next two operas, each running about an
hour, would be composed much faster. I set “Usher House” to my earlier libretto
based on Poe’s story in about six weeks in 2008 and 2009. “The Canterville Ghost”,
on Wilde’s short story, took me about two weeks each, with two months between,
Chapter 1: Recollections 1/06/16 14
for libretto, composition and orchestration. The last two operas have been
premiered at major opera houses. Usher House ran again at San Francisco Opera.
Upcoming performance of the “scare pair”, meaning Usher and Canterville as a
double bill, have been announced in other cities. Plump Jack is still waiting its turn.
My interest in human origins led me to the Leakey Foundation. I had read about
Louis Leakey in the papers, and had met him a few times in Las Angeles and San
Francisco. Brilliant, courtly, fierce. He let you know what was wrong. I became a
fellow in 1973, a trustee the next year and chairman the next.
Clark Howell, who taught anthropology at Berkeley, chaired our science committee.
His co-chair was Dave Hamburg, a Stanford psychology professor who specialized in
great ape studies or primatology. Most leading scientists in either field were
members or regular advisors. They recommended grants, and we trustees funded
them. We took a venture capital role, usually making grants of a few thousand
dollars to promising new prospects rather than bigger amounts to steady-state
projects already proved. Those proved ones included Jane Goodall’s chimp studies at
Gombe or Richard Leakey’s digs at Lake Turkana. National Geographic, or the
Wenner Gren or World Wildlife or National Science Foundations tended to fund the
known winners. We’re a lot bigger now. I am one of the few living links to those
great people and times. We’ve evolved with the science. But we stick to the venture
capital role.
That always left time to organize lectures and symposia. A few of us including Nancy
Pelosi, long before she tried politics, put together an all-star two-day symposium at
the Palace of Fine Arts in the San Francisco Marina district in 1973. Tickets sold out,
and hundreds watched on screens set up in the lobby. Julian Huxley regretted, but
sent his good wishes on tape. The octogenarian Raymond Dart recounted his
discovery of australopithecus africanus at Taung cave near Johannesburg in 1924.
Louis Leakey had died the year before, but his equally legendary widow Mary
updated us on the digs at Olduvai. Dick Hay filled us in on the geology there. Jane
Goodall gave the news from Gombe. Dave Hamburg reported on the new
Chapter 1: Recollections 1/06/16 15
chimpanzee compound near the linear reaction at Stanford. Clark Howell briefed us
on his work at Torralba and Ambrona in Spain, where our ancestors half our size
had hunted elephants twice the size of modern ones. (Elephants go back at least as
far as mammoths and mastodons.) Desmond Clark covered African archaeology in
general and his discoveries at Kalambo Falls in particular. Sherry Washburn showed
the way in which our DNA is 98% the same as a chimp’s. All were my close friends.
It was at a symposium in 1974, in Washington I believe, that I first heard and met Irv
DeVore. His talk was on evolutionary biology and Hamilton’s rule. Both were new to
me. Irv was a champion speaker. Students packed his anthropology classes at
Harvard. He became a Leakey stalwart and a particularly close friend.
I liked his topic. Genes code for traits, and traits more adaptive to niche pressures
are likelier to carry the genes that encode them into the next generation. The
likeliness is “fitness”. A beauty of this is that you can predict traits from the
environment (niche), and the environment from traits. That promised the kind of
logical challenge that I loved.
Survival of the fittest was not news to us. What was news was that bright scientists
like Irv were specializing in that logic, and making testable predictions for creatures
generally, humans included, rather than sticking to the groups they studied most.
That meant people I could talk to.
Hamilton’s rule was put up as the prime example. It starts from the principle that
the end game in biology is investment in the next generation. Hamilton had
reasoned in 1965 that genes coding for most efficient investment in closest kin, who
were likeliest to carry copies of those genes, ought to leave most copies in the next
generation. We would invest in them when consanguinity was greater than
cost/benefit ratio measured in fitness given up and fitness gained at the other end.
I didn’t like this. Something was missing. The logic was seductive. But Achilles does
overtake the tortoise. Traits compete, like those racers, for niche space. The winner
is the fittest at meeting needs of the niche. Hamilton’s rule seemed to leave that out.
Chapter 1: Recollections 1/06/16 16
It got Darwinism backward. Darwin’s idea was that the best-adapted leave most
progeny, not that leaving most progeny or other close kin somehow bootstraps itself
into adaptiveness.
The math of Hamilton’s rule didn’t work either. In diploids like us, where each
parent carries two sets of chromosomes, closest relatedness without inbreeding is
½. That meant that fitness would have to double or more with each generation. The
reason is that fitness not expected to be transmitted to successors would be a
contradiction in terms. If it cannot be transmitted (invested) at less than a 2:1
efficiency ratio (benefit/cost ratio), then it must be expected to double or more with
each reinvestment. But aardvarks and flatfish aren’t 1024 times fitter than their
ancestors of ten generations ago. They aren’t even a smidgen fitter, by any measure
of fitness known to me, unless the population has grown. Population growth in
nature usually fluctuates around zero.
But his rule was right in important ways. Nepotism is common in nature. The Trust
passed my father’s wealth to direct descendants. Most wills do, or favor nephews
and nieces as a secondary choice. Chimp mothers maneuver to push their offspring
up the social ladder. Worker ants and bees, who don’t breed, push the chances of
their younger half-sisters. Hamilton’s rule was clearly a good rule of thumb, even
though the math needed tuning. Why should it usually work? I couldn’t know then
that Hamilton himself would find the biggest missing piece of the puzzle in 1982.
Economics was always somewhere on my screen. It was the biggest challenge
because I had to reinvent it from scratch. I had dropped the course at USF because I
couldn’t find the foundations. But we don’t build a foundation without knowing
what we want to top. I had to reinvent everything at once. Does that mean I thought
I was best qualified for such a task? No. Plenty of people are better at logic than I am.
Rather I seemed to be the only volunteer.
Explicit economic axioms are seen as a nineteenth century thing. There are implicit
ones to a degree. Macroeconomics is said to rest on microeconomics, and
microeconomics on the logic of supply and demand. Good so far. But I felt the need
Chapter 1: Recollections 1/06/16 17
of a logical context for those. Too darned much was being taken for granted. What
do we really want from economics? As we gradually figure that out, we can figure
out the most efficient vocabulary for description and prediction. That’s was what
Newton did. I didn’t like the lazy assumption that those problems had already been
solved.
Newton lucked out in that old words like mass, force and energy would mostly do if
he gave them exact definitions within their usual ranges of meanings. Brand new
terms would have made tougher reading, and his Principia Mathematica was tough
enough in 1687. I had the same luck in the end. But I didn’t know that until I had
collected textbooks and economic dictionaries, along with most books on economic
history I could find, and meanwhile worked out what I thought the right vocabulary
ought to be. We pretty well have to solve every section of the jigsaw puzzle at the
same time. I’m my father’s son, by the way, and balked at the three-figures prices of
some of those textbooks, even though I might fork up as much for a bottle of wine.
My ideas on growth theory and capital theory (explaining rates of interest and
return) will get plenty of coverage later. It happens I have also taken a lifelong
interest in banks and money theory. This book isn’t about that directly. But banks
and money are part of the story of growth and interest, and anyhow are worth
attention in themselves.
Money has been defined elegantly in terms of what we want from it. We want a
measure of value and a medium of exchange. The qualities to give those things are
“moneyness”. Money should be “transportable”, for one, in that we don’t really want
to lug bags of wampum around. It should be stable in value, so that we can contract
over the future with least uncertainty. It should have the same value in different
places as well as at different times, to minimize the nuisance of conversion. There
should be enough of it that shortage doesn’t drive us to the clumsiness of barter. It
should be “divisible” into tiny units, as hundred-dollar bills into tens and ones and
pennies, for exact payment with nothing owed back. It should be fungible in that one
Chapter 1: Recollections 1/06/16 18
unit, say dollar, is worth exactly the same as another. Most essential of all, money
should be something actually and reliably valued.
What meets all these criteria? Gold has been a contender since ancient times. But
how reliable is its value? Spain and Portugal stockpiled gold and silver from the new
world for two centuries, and bought nothing but inflation for their trouble. Gold is
good for filling teeth, and for displaying status so long as it is rare. Then what is
better?
Two brilliant and dangerous adventurers, the Scotsman John Law and the Irishman
Richard Cantillon, proposed land. France in 1720 had no new world mines, and
needed money. It had plenty of land in Mississippi. Law and Cantillon put two and
two together. I think they sincerely believed their advice to The Duke D’Orleans, the
regent after the death of Louis XIV, that land could be the most reliable basis of
value then known. More than that, I think they were probably right. But it wasn’t
reliable enough. Early investors in paper rights to the land had made a mint as
others crowded in. Market euphoria led to more paper rights than underlying value.
You’ve heard that one before. Law and Cantillon saw the crash coming. It would be
called the “Mississippi bubble”. Cantillon sold out just in time. Law preferred to face
the music, as I would in the Neutral Zone a quarter millennium later. Land wasn’t
the answer.
I can’t call Law and Cantillon good guys like the emir. Both seem to have committed
murder for money, Law long before and Cantillon long after, in scandals in London
having nothing to do with the bubble. But they had good days. Cantillon’s book,
which I know only from descriptions by economic historians, seems to be a
masterpiece of the obvious-in-hindsight. Law went down with the ship, like a
mensch, and seems to have kept the trust and friendship of many backers he had
bankrupted. I mention the plusses of these two men to remind us that the truth is
seldom black and white, and to mitigate the folly of the French in trusting them.
Money today, in the United States and elsewhere, is not backed by any commodity. It
is “government fiat money” backed by the taxing power of government. That may be
Chapter 1: Recollections 1/06/16 19
the best solution tried so far. The value behind the taxing power is the total capital
of the nation, meaning human as well as physical capital. And the dollar has proved
pretty stable since Paul Volker’s tough reforms in the early 1980s. That means that
government fiat money in this county is working about as well as anything we have
known.
But there are problems. Government tools for stabilizing government fiat money,
which has no value in itself, are limited to control of its supply. The tools are
monetary and financial policy. Monetary policy is mostly “open market operations”
where government sells bonds to soak up excess money, and buys them back again
to put money back in the system. You can also raise or lower Central Bank interest
rates to get the same effects. Fiscal policy trims money supply by raising taxes and
cutting government expense, and pumps money back into people’s hands by
lowering taxes and raising government expense. Monetary policy is the tool of
choice because it has acted must faster. But either policy, or any mix, is a tightrope
walk. Too much money courts inflation by motivating people to spend rather than
save. Too little courts recession by motivating the opposite. That’s why
macroeconomics is said to rest on microeconomics. Are we wise to push our luck on
that tightrope forever?
Another problem is that our current money system may depend too much on banks.
Banks buy and sell back the government bonds, for example, and create the money
they lend by writing it into the borrower’s checking account and booking the
promissory note as value received in return. The problem is that banks are failureprone.
I mean plain commercial banks which do nothing but accept deposits and
make loans, not the still more dangerous commercial/investment hybrids which
rose and fell after repeal of the Glass-Steagle Act.
The danger is leverage. Depositors must be attracted at some cost, say checking
services. Borrowers must be attracted at a rate covering those costs to give profit in
the first place. Then equity investors must be attracted at an equity rate, generally
higher because equity imposes risk. These rates and costs are market givens rather
Chapter 1: Recollections 1/06/16 20
than what the bank decides. Then how can profit from lending rates, watered down
by costs of attracting depositors, translate into higher equity rates?
Easily, but dangerously. That’s where the leverage comes in. If the amount borrowed
is much larger than the amount invested as equity, absolute profit from borrowing
might be large compared to the amount invested. If hens lay only one egg per day,
but I own three hens, then I can eat three eggs a day.
More money lent out, compared to equity invested, presupposes more deposits to
lend. The leverage needed, or deposits/equity ratio in the bank’s case, works out to
equal the market equity return for investments of equal risk, divided by the market
borrowing rate for loans of such term and risk, net of expense percent including
costs of attracting depositors. This has tended to pencil out at about ten to one.
Firms in general are considered risky when leverage (debt/equity in that case)
reaches one to one. Four to six is more typical. Not ten to one. Banks invest in loans,
which are safer. But not ten times safer. Few people today would risk their money in
bank deposits without federal deposit insurance. My own reading of history finds
that deposit-and-lend banks have failed systemically, or needed bailouts, about once
per generation since they were innovated in Marco Polo’s time. They failed because
borrowers default in high winds, and defaults are magnified tenfold in effects on
stockholders’ investment. We rebuilt them, and the tenfold leverage, because we
blamed the high winds rather than the rickety structure. The Practical Pig knew
better.
It began occurring to me in the mid 90s that mutual funds might replace bank
deposits, and deal with the tightrope problem too. Too much money burns holes in
pockets today because money earns nothing while we hold it. Mutual funds pay
returns, and are owned for their own sake. If their shares were somehow money,
people would feel no impatience to spend it, and no supply would be too much. I
gradually figured out how the obvious problems in fungibility and divisibility and
other moneyness qualities could be addressed.
Chapter 1: Recollections 1/06/16 21
Nobelist Franco Modigliani heard of this, and invited me to MIT for a presentation.
He talked like Gepetto in Disney’s “Pinocchio”. There were a few other top brains,
including Ruddiger Dornbusch and2Julio Rotemburg, in the small classroom where I
spoke. Sometimes Modigliani interrupted. “Getty, you don’ta consider this.” “You
forgeta that.” I guess I thought I wasn’t doing so well.
My talk ended, and he and I were standing by a window. To lighten the mood, I said
something about the Red Sox. He said “Getty, I getta papers on banka reform every
week. Yours isa the best.”
Milton Friedman, another nobelist, had a different take. We had given talks at a Cato
Foundation symposium in San Francisco. He hated my idea. No great surprise. He
had written that money ought to earn nothing so that we wouldn’t own too much.
Any attempt to back money with anything, he told me, would meet John Law’s fate
in the Mississippi bubble. The backing commodity would become inflated and then
crash. So Nobelists can disagree.
My version of the same idea today looks first to ETFs (exchange traded funds),
which are more liquid and money-like than mutual funds. ETFs are usually index
funds, which replicate index holdings with no active management and so charge
very small expense ratios. But mutual funds might become money too. My idea, dead
opposite from Friedman’s, is that both money supply and money yield should be
held as high as possible.
What would happen to banks? Major angst, but not much damage. They would
devolve into their separate deposit and lending specialties, with separate
stockholders and only incidental interaction. Deposits would be invested in ETFs or
mutual funds. Federal deposit insurance would wither away as unneeded. There are
no runs on ETFs. Lending banks would have to raise funds to lend from investors
expecting a return.
Is there a downside? There is certainly a risk of one. The devil we don’t know is
what would happen to lending rates and what the consequences might be. That had
Chapter 1: Recollections 1/06/16 22
been one of Modigliani’s points in his interruptions. Federal deposit insurance
subsidizes cheap money and keeps lending rates low. Most tradition associates easy
money with growth and prosperity. Higher interest rates are associated with
restraint in investment and consumption both. Modigliani was right to worry.
My guess is that the bank reform and money reform I propose would drive
borrowing costs up, borrowing volume down, and equity investment up to fill the
gap. Corporations would issue new stock to retire corporate debt. Newlyweds
would rent, not buy, until their incomes were high enough to bring other options.
Modigliani was also worried that monetary policy would become impossible. It
would as we know it. I have argued elsewhere that fiscal policy can be made to work
as well and as fast. And I will argue for an unusual and more direct form of monetary
policy. But no one knows.
These concerns are reasons to go slow. I think that the reforms I describe are
developing now, with no input from me, and will continue if they succeed.
Depositors will be attracted away from banks to ETF accounts of equal liquidity and
full return. Federal deposit insurance will not be advantage enough to hold them.
Banks will get the message and join the parade by spinning off their loan
departments and investing deposits in ETFs. If Modigliani’s valid concerns haven’t
found good answers, the parade will stop until they do. It could backtrack to the
starting point. The reforms I believe in ought to work, but can be scrubbed without
much mess if they don’t.
I am not their only advocate. Others argue for splitting up commercial banks more
or less as I would. Meanwhile many people maintain liquidity in ETFs or mutual
funds rather than banks. There may be some originality in putting the two reforms
together.
This personal account can end with more thoughts about my father. My stepmother
Teddy’s touching book about their marriage, out a couple of years ago, tells the truth,
the whole truth and nothing but the truth. That what she does. He seems not to have
Chapter 1: Recollections 1/06/16 23
been the easiest guy to be married to. He pinched pennies, went on trips while she
held up the home front, came home late. My mother had about the same story. But I
saw different sides of him at different times and places.
Twice I saw him cry. Once we were listening to a Caruso record. He might well have
heard Caruso, although I don’t recall that he said so. He would already have been 28
when Caruso last sang at the Met. One of the two books he wrote by himself shows
him as an opera buff when on his own in Germany in the 1930s. He wrote what
operas he had heard, who sang, and what he liked. My mother said the same. Once
they arrived late at a performance of La Boheme somewhere on the Riviera, couldn’t
find a program, liked the tenor, decided to help him, and learned that they had failed
to recognize Beniamino Gigli.
The other time was about his and Teddy’s son Timmy. Timmy’s brain tumor was
inoperable and growing. He was 13. The doctors had told them to prepare for the
worst. We were in London. The papers said something about young toughs called
Teddy boys. My father started crying. Timmy wouldn’t make it, and the Teddy boys
would.
I’ve now lost a son myself. You thank the graces for what’s left to do. What’s left to
do includes composing, verse and economics. The first has panned out okay. A fair
bit of the verse was set in the music. At least that makes it read and heard. Aside
from the kind words of Modigliani and a few others, I can’t say as much for my
economics. So here goes again.
Chapter 1: Recollections 1/06/16 24
CHAPTER 2: FAST FORWARD
I dropped the course on economics because I couldn’t see the foundations. Not that
they should be clear from the start. That isn’t how the mind works. We see, do and
understand in that order. The pyramids rose four thousand years before people like
Galileo and Newton found the laws that made them possible. Practice comes first,
and science last. Science is abstraction from the particular to the general. It is fewer
rules predicting more outcomes more exactly. The pyramid builders knew rules for
this kind of stone and that kind of wood or rope. Newton gave rules for mass and
force. Those are not particular things like stone and wood and rope. They are
qualities of all things. Their rules are tougher to get our minds around, but predict
everywhere once we do.
What a book or course should offer from the start, even before the foundations, is an
inkling that it should be worth finishing. We have to sense that we’re on to
something. The price of getting there will be the nuisance of abstraction from things
to qualities, and we need to see a reason to pay it. I didn’t in the course on
economics. Now it’s my turn. I’ll try a fast forward through free growth theory and
my other arguments to give an idea where we’re headed and why it matters. The
foundations and then the slower tour will follow.
Free Growth
What I call free growth theory will probably count as the chief surprise, at least to
non-economists, because the argument and the supporting evidence call for a major
reversal in tax policy of this and other nations. But it is not original. John Stuart Mill
wrote the same idea in his Principles of Political Economy in 1848. I will quote what
he said in my Chapter 4. Although Principles became a leading textbook for decades,
the paragraph I quote seems to have been overlooked. Economic historians
including Joseph Schumpeter describe him as a champion of growth through belttightening.
The paragraph I will quote makes the opposite clear. We now have
means to prove his idea. I will show how to test it, and will show test results in
charts and tables taking up about 20% of this book. They imply that tax laws
Chapter 2: Fast Forward 1/06/16 1
encouraging investment over consumption and plowback over dividends,
particularly in the last half century, have led to dangerous overinvestment in the
private sector. The empty eyesores and bulldozer bills of 2008 are symptoms of proinvestment
policies founded in many countries after World War II. They did no
harm when the world needed rebuilding anyhow. But I suggest that output growth
slowed because of them, not despite them, after 1970 or so. I will argue that optimal
investment at the national scale, strange as it sounds, is depreciation plowback and
nothing more. Mill showed how that could be true. The same growth will arrive, say
he and I and the charts and tables, with no consumption sacrificed. More
consumption at no cost to growth adds up to more output. Output nosed down
since 1970 or so because we squelched consumption to no purpose.
That means only private sector overinvestment, prompted by unwise tax motives,
and only at the collective scale. Government follows different motives, and has
somehow followed them to an opposite problem in this country. Our infrastructure
rusts and crumbles. It seems that our good friends in the Tea Party think that roads
and bridges undercut market freedom.
Growth is interesting, even without these opposite distortions, because history is
interesting. Growth is our history. It is not the history of other creatures, who repeat
norms from generation to generation once evolved. That’s why the math of
Hamilton’s rule doesn’t work. And we care about it because there are emotional and
moral and belly issues attached. I gave an idea of its dangers in the foreword. The
past has proved survivable. The future has not. Then what about its cost? Does
faster growth need consumption restraint at the start? Is it a reward for sacrifice?
That’s what Mill tried to answer in 1848.
He started with the idea that output, meaning creation of capital, must mean growth
of capital (“investment”) plus consumption. I will call this the Y = I+C (or Y = C+I )
equation from the standard notation economists use. I will argue that it is true with
two adjustments. Investment must include investment in human capital, and
Chapter 2: Fast Forward 1/06/16 2
consumption must exclude any schooling or nurture already counted in that
investment. (Schooling counts as consumption.) Mill would have understood the
human capital concept, defined by Sir William Petty nearly two centuries before, but
economists only recently have begun to take it seriously. Mill’s meaning of the
Y = C + I equation, and the one accepted everywhere in macroeconomics even today,
leaves out the growth in human capital and includes all consumption.
That equation, which I will try to prove correct if we make the two adjustments,
shows that less consumption brings faster growth if output holds still. But nothing
in the equation says it will. It says that less consumption means either more growth
or less output. It doesn’t say which. John Maynard Keynes, probably the most
famous and influential economist of the 20 th century, put this fact of math a special
way in his General Theory of 1936. In his analysis, saving through less consumption
is either invested or not. Since output is consumption plus investment, saving
uninvested is so much less output. I like to put the same idea with a range of degrees.
All saving is invested, as I use the word, but finds different returns. Saving under the
mattress is investment at zero return, and drops output just as Keynes said.
Investment at the current average return keeps output unchanged. That’s what
Keynes meant. But investment at lower returns lowers output, and conversely.
Keynes’ version sees intended saving (consumption restraint) as either invested or
not, and sees it as translated dollar for dollar into actual capital growth if it is. Mine
allows any degree of capital growth below or above the actual cost of investment in
consumption given up.
This is a surprising concept, either in Keynes’ version or mine, because it seems to
fight personal experience. Until the next raise or job change or layoff, our incomes
seem to be known quantities. If we skip desert, and watch TV instead of going to the
movies, we can put more in the bank. At least our incomes will not drop because we
saved those costs. But it is different for all of us collectively. When the whole nation
saves, and either does not invest or invests less productively, output drops. Keynes’
analysis says the same, but leaves out the “less productively”.
Chapter 2: Fast Forward 1/06/16 3
My reading of the Mill paragraph says that if we plowed back only depreciation
investment, without invading consumption for more, we would still grow if that
investment paid off in higher returns than the current norm. Then capital would
grow faster without making consumption grow slower. The gain in output, even
though we had invested only enough to make up for depreciation while keeping
consumption the same, would have been split into some for capital growth and
some for more consumption. And Mill gave the reason for the gain in output. The
driver was “whatever increases the productive power of labor”. He was talking
about better ideas. We would make returns higher if we could make capital more
productive at the same cost.
This possibility troubled Nobelist Robert Solow, who came reluctantly to a
conclusion most of the way toward Mill’s a century later. He felt that growth should
not be a gratuitous deux ex machina arriving at its own whim. How could Mother
Nature say “Shazam” and turn less into more whenever new ideas come along?
Didn’t the capital chicken have to grow before the output egg? Didn’t we have to
tighten belts to invest in new plant applying those new ideas? But the evidence
seemed to say that the rise in output came first. Rise in capital followed. Thrift
seemed to play little role. Tests by others have tended to find the same thing since.
My own tests, using new data from national accounts and my own new testing
method shown in my charts and tables, reduces the role of thrift to zero. How could
that be?
How could better kinds of capital arrive without costing more, at least at the start,
than the kinds we already knew? My best guess is that the cost of innovation in
failure rates and learning curves is the cost of being human, that we pay it about the
same every day, and that growth happens when the worth of innovation proves
more than the cost. It can because we are human. The cost of being human means
the cost of adapting. It is how we cope. We turned in our fangs and fur in exchange
for the savvy to make tools and fire and clothing do better. Other creatures adapt
Chapter 2: Fast Forward 1/06/16 4
too, but we became the specialists. Adaptation grades into innovation whenever it
somehow becomes a norm. That too happens with other creatures, but not as often
or as lastingly. Their new norms almost always revert to the old ones. Our
innovations collect and accrue. That’s why growth is our history.
Its costs are failure rates and learning curves. Many innovations are blind alleys, and
most others need shakedown runs. But we’re stuck with those as the cost of being
human. And we’re stuck with them whether the result right now is growth or not.
They were our cost of survival during our million years as homo erectus, when the
archeological record shows little overall change in the stone tools we made. Growth
and lasting innovation picked up marginally with the emergence of Ancestral Eve
and bigger brains about 200,000 years ago, and began accelerating about 50,000
years ago. Growth happened because the more or less constant cost of adaptation
and innovation became less than the payoff. New ideas finally found traction at no
added cost. Mill’s idea was that more payoff in growth need not presuppose more
sacrifce.
Does that mean that all we need for growth is new ideas and the courage to trust
them? Well, no. We still have to plow back depreciation as the cost of holding even.
We need practical savvy and patience too. Sometimes great new ideas must wait for
an opening. That may be why our bigger brains showed little effect on the kinds of
tools we made until about 50,000 years ago. And I will argue that innovations need
laws and customs that welcome them. Otherwise they will make a few bucks for the
local warlord rather than wealth for the originator and the world. But what they
don’t need, say Mill and I and the data, is tighter belts.
Adam Smith, in his Wealth of Nations published in 1776, proposed growth by belt
tightening. Most tradition has agreed, with the proviso that new ideas must come
first. Solow raised doubts about the role of consumption restraint, but stopped short
of denying a need for it. Mill acknowledged both ways to grow. My charts and tables
will confirm that only the kind that troubled Solow has actually happened, in every
Chapter 2: Fast Forward 1/06/16 5
country and period tested. I call it free growth. My own free growth theory
acknowledges growth by consumption restraint, which I call thrift, only as a
mathematical possibility which doesn’t seem to happen. So my idea, taking account
of data Mill didn’t have, is different from his. I must be careful not to put my ideas in
his mouth. When I say “Mill’s idea”, from now on, I will mean some of both.
No one had the data to prove him right until national accounts began reporting
market-valued capital in 1990 or so, and reconstructing it for a few decades before.
What they had earlier was the book measures of capital that we see in balance
sheets. They don’t reveal enough. Book measures assume depreciation norms.
Outcomes converge to norms over time, but meanwhile might be anything. National
accounts follow a form of this book or depreciation accounting. They now report
market-valued capital too, but still prefer book methods to calculate investment I
and output Y in the Y = C + I equation. That doesn’t work well. Did you know that
national accounts in France, Germany, U.K. and the United States all reported
positive net investment in the crash years 1929, 1930, 1937 and 2008? Net
investment, meaning net of depreciation, is intended to show growth in capital value.
Do you think values really went up in those crash years? And national accounts can
be just as wrong in the opposite direction. In the boom year 1933, when stock
markets were up 42%, 67%, 96% and 46% in those four countries, Germany and U.S.
reported net investment (capital growth) as negative while France and U.K.
reported it up less than half a percent. All this shows in my charts and tables.
Reports of net investment in national accounts tend to prove radically wrong in
years of unexpected upturn or downturn because they don’t get the news of wars or
national disasters or discoveries or business cycles until new assets are bought or
new products sold. Purchases and sales are normally the only input into the books.
Average time between original purchase and realization in sales is the “holding
period” or “turnover period” of capital. For all physical capital together, it runs
several years. Accounts in those slump years were reporting the good news of boom
years shortly before, including the booms of 1935 as well as 1933 preceding the
slump year 1937. Accounts in the boom year 1933 were finally getting the news of
Chapter 2: Fast Forward 1/06/16 6
the crash. (Yes, some of the strongest boom years in history came during the world
depression.)
This is not to question the need for national accounts. We could not manage without
them. But the genius of accountancy is in its reporting of cash flow items.
Depreciation, even its sophisticated form used in national accounts, is a makeshift
approximation better than nothing. I argue that it is obsoleted by our access to
market-valued capital appearing in the last few decades.
Mill’s argument was that capital growth might be explained by productivity gain as
well as by thrift in deferred consumption. The way to test between them that I will
describe takes measurements of market-valued capital, its year-to-year change in
these, and consumption at the same time. I call it the simultaneous rates method. In
any year and country where consumption restraint explains growth, although the
data show none, rise in growth rate would equal current drop in consumption rate
(consumption/capital) while rate of return (output/capital) holds unchanged. When
productivity gain is the explanation, as the data confirm so far, it is consumption
rate that holds the same while growth rate and return rise equally. That’s what I
test. Data in charts and tables for those four nations from 1870 through 2010, and
from Australia, Canada, Italy and Japan from 1970 through 2010, show that faster
capital growth coincides with higher consumption rates in the same year as often as
not. Less consumption has simply meant less output with no growth to show for it.
That is the sense in which growth is free.
These countries and periods are not cherry-picked to support Mill’s idea. They are
all I have found. My source for national accounts including market-valued capital
was the website of Thomas Piketty and Gabriel Zucman adjusting their data to
uniform accounting standards and measuring them in 2010 currency units. It also
collects recent and past research by other economists modeling what national
accounts, again including accounts of market-valued capital, would have shown in
years before they were founded in 1930 or so. Simon Kuznets, for example, who
Chapter 2: Fast Forward 1/06/16 7
founded the national accounts in the 1920s and reorganized them along Keynesian
lines when the General Theory was published, reconstructed them back to 1870 for
the U.S. economy. Piketty and Zucman incorporate this research and others. They
have acted as editors only. As a layman, I would hardly be qualified to find and
interpret original sources. Even most economists might lack that specialty. I simply
trust Picketty and Zucman. They will have compounded misreadings and editors’
bias in those sources by adding their own, and I will have added mine. They and I
have plenty. Editing is bias by definition. But we can’t do without it. We manage as
best we can.
To make sure, I also test Mill’s idea on stock market data from the same nations and
periods. Here my source was the Global Financial Data website marketed by
Bloomberg. Market cap corresponds to capital, dividend yield to consumption and
total return to output. Charts and tables show free growth as essentially all of
growth in stock markets too.
Now try a first look at the charts and tables. The lollipop-shaped Greek letter ϕ
(phi) is something I call the free growth index. It reads 1 in years when growth is
explained as Mill described, 0 in years when belt-tightening was the explanation,
and something in between when there was both. The free growth index will be
explained in chapters 4 and 5. The charts can be messy, and the data jumps around.
There are spikes, both up and down, which tend to disappear in the charts which
screen out small absolute values of the denominator (capital acceleration). But the
free growth index clearly jumps around 1, not zero, both before or after the
screening. It is as often above 1 as below. That means that growth is as likely to
coincide with belt-loosening as belt-tightening. My free website
FreeGrowth&OtherSurprises.org shows how everything was calculated.
Economists will not be as surprised as they might have been a century ago. Growth
theory since Solow’s revolutionary papers in 1956 and 1957 has marginalized
Chapter 2: Fast Forward 1/06/16 8
capital accumulation or thrift, and has seen most growth at the national scale as
“exogenous” or unexplained by whatever we suppose that we give up in exchange.
This book takes the next step in the same direction. The role of thrift is zero. It is
politicians, not economists, who will be flummoxed. The double tax and the tax
preference for capital gains are examples of policies favoring investment over
consumption to benefit growth. The record shows no such benefit in any country
ever. From all evidence so far, free growth theory is free growth fact.
A New Way to Measure
What this book tries to add is not only the next step in Solow’s direction. My
simultaneous rates method offers a new means of testing. Twentieth century growth
theory, led first by Keynes’ colleague Sir Roy Harrod and then by Solow, has tried to
gauge the effectiveness of consumption restraint by a different method from Mill’s
and mine. It has looked for effects on later output rather than on current capital
growth. I call it the lagged flows method. Why the lag? Because if output is growth of
wealth (capital) plus consumption, a shift from the third to the second cannot
change output at the same time. Rather output should benefit after a lag of a few
years for the capital that produces it to accumulate. Capital investment plants a tree,
and output growth is the new fruit expected to follow.
The lagged flow method makes sense, and there was nothing better until data for
market-valued capital began appearing in 1990 or so. But the lag tends to blur
causality. Later changes in output could have later causes. And output itself, after
the lag, could not be measured reliably for lack of the same data. It has been
measured as gross or net domestic product, reported as the sum of consumption
and book investment. Books don’t get the news until new assets are bought or new
products sold. We just saw the anomalous book results reported for 1929, 1930,
1933 (the opposite distortion), 1937 and 2008. Those are not the only examples. My
method measures output as consumption plus change in market-valued capital. It
seems to me that Piketty and Zucman ought to have shown output this way, at least
as an alternative version. Isn’t it inconsistent to measure capital at market, but to
Chapter 2: Fast Forward 1/06/16 9
measure its change (net investment) at book? And isn’t it better to measure the
effectiveness of thrift with neither the lag nor the well-known problems of book
depreciation?
I will show the math of my simultaneous rates method in Chapters 4 and 5. Chapter
4 reasons from the Y = C + I equation, even though I don’t accept it, while Chapter 5
translates findings into the new version I do accept. Charts and tables show both
versions for all eight countries reported, over all years reported, and run the
averages. The thrift index, or ratio of the supposed cost to actual growth, averages
zero. I found it best to show separate charts for each country by each of the two
versions of the Y = C + I equation and by each of three levels of denominatorscreening
(none, then two progressively wider screens). Other charts track other
data that seemed informative. That explains why charts take up so much of this
book.
This completes my first survey of free growth theory and its support in the data.
Chapters 4 and 5 will cover the same ground again from new perspectives. So it will
be with other themes of this book and other chapters. My problem is to sell
unfamiliar ideas, although not necessarily new ones, and in somewhat unfamiliar
language too. My “simultaneous rates method”, yet to be clarified, is an example. I
use the standard language of economics where I can, but must sometimes tweak
words or coin them. We will see that in Chapter 3. I try to cope with that double
challenge – unusual ideas in unusual terms – by the same strategy of restatement
from new perspectives until all fits together.
Fixing the Y = I + C Equation
If I had any sense, I would pretend to accept the Y = I + C equation as Mill and all
other economists seem to do. Then I could have done with only half as many charts,
and made this a book about free growth only. Any fool knows that a book should
pick a focus. The data confirming Mill’s idea would have made a spectacular finale.
Why undermine my own case by questioning his assumptions? So I should probably
Chapter 2: Fast Forward 1/06/16 10
have played dumb and quit ahead. But that would have left out half the story and all
the other surprises. I confessed that the surprises are the features I can’t resist. If
they are fun for me, I can accept the challenge of making them fun for the reader.
Anyway, I already opened that can of worms by showing that I don’t accept the
Y = I + C equation even though others do. I gave an idea why, and can sketch my
reason out a little farther.
It begins with something I call the total return rule or total return truism. The
truism is that creation of value equals growth of value plus cash flow, where cash
flow means value taken out less value inserted from outside. I don’t think anyone
doubts this truism, which is fundamental everywhere every day in the investment
world. I will prove it anyhow, just for good measure, in the next chapter. It is
probably the reason that the Y = C + I equation is readily accepted. Net investment I
is meant to show physical capital growth. It could look to be the growth in value, if
we don’t consider human capital, and consumption C could look to be the value
taken out.
But a second look is needed. The logic doesn’t work unless we consider all value
including human capital. Some consumption is invested in human capital, and only
the rest exits the whole economy in satisfying tastes. Then the equation would still
be true if the invested part of consumption equaled human capital growth.
The reason why it doesn’t starts with what we already know about human capital.
Petty in 1664 had hit on the idea of this as time-discounted future lifetime pay.
Adam Smith in 1776 saw it equivalently as accumulated past investment in nurture
and schooling. The Americans Irving Fisher and Frank Knight revived both ideas in
the early 20 th century. The tempo picked up after World War II at the University of
Chicago. Jacob Mincer rederived Fisher’s present value equation in 1958, and
modeled investment in human capital through job training. Nobelists Theodore
Schultz and Gary Becker soon joined in. New insights included the realization that
human capital grows from the self-invested work of learning, as well as the outside
Chapter 2: Fast Forward 1/06/16 11
input of nurture and schooling, and then depreciates gradually to zero just as
buildings do. Yoram Ben-Porath combined these ideas and more in a masterly lifecycle
model published in 1967. We’ll get to it soon.
Schultz called the part of consumption exhausted in taste satisfaction “pure
consumption”. The part invested in human capital was “pure investment”. I change
that to “invested consumption” to avoid confusion with investment in physical
capital. Since there is no settled term for the part of work invested in learning, I call
it “self-invested work”. I call the part of work sold for pay “realized work”. Then the
consensus view formed in the 1960s held that human capital growth equals
invested consumption plus self-invested work less human depreciation. I agree,
with a clarification as to possible deadweight loss that I’ll come to in Chapter 6. I call
it the Ben-Porath equation, although he drew it from the Schultz-led consensus. It is
really a summary of the first four of the equations in his 1967 paper taken together.
This explains my critique of the Y = I + C equation. The equation would be true if
human capital growth equaled invested consumption. In fact it equals that plus selfinvested
work less human depreciation. The corrected equation would read “output
equals consumption plus investment plus self-invested work less human
depreciation”. I call this the “Y rule”.
Upending the Y = I + C equation is big news. Macroeconomics and the national
accounts are founded on it. That’s one reason, although not the main one, why I
think that macroeconomics should start over. It doesn’t follow that national
accounts in themselves need much change, aside from reporting net investment at
market as well as at book, because accountants must measure what they can.
Human depreciation and self-invested work elude market measurement. But
economists can allow for them, and they are huge flows. Human depreciation is
depreciation of the larger factor. And self-invested work includes more than
learning. Ben-Porath showed, as we will see, that it equals all growth in human
capital not explained by inflows of nurture and schooling less outflows in human
Chapter 2: Fast Forward 1/06/16 12
depreciation. That implies that it includes all free growth of the larger factor. And
these huge flows would figure to be uncorrelated. Depreciation of either factor is a
steady drag on growth, while free growth is revealed in the charts and tables as a
bucking bronco which might be double-digit positive one year and double-digit
negative the next. No wonder that national accounts cannot reliably tell good years
from bad.
Another distortion in the Y = I+C equation is the undue prominence given to
consumption. Physical capital, in most views including mine, is only a third to a fifth
of total including human capital. Human capital is the lion’s share. Pure
consumption is most of consumption, in my view, but not all of consumption. If the
factors grow in mutual proportion, then, the ratio of total capital growth to pure
consumption will be much higher than of net investment to all of consumption. That
explains, I think, why national accounts have reported not a single year of negative
net product in any of the eight countries since inception. Balanced portfolios report
negative total returns every few years. So would net product, were it not dominated
artificially by the steady positive of consumption. It is as if a portfolio dominated by
investment grade bonds were taken as representative of a realistically balanced
portfolio.
Solving the Age-Wage Puzzle
I will now try to solve a feature that troubled Ben-Porath and has troubled many
economists since. I call it the age-wage puzzle. Age-wage profiles are published
reports comparing pay earned by all working ages at the same time. Since all
cohorts (same-age sets) are compared at once, as in a family portrait, age-wage
profiles do not show effects of technological growth over time. They show effects of
age and experience alone. What appears is that pay or wage rises steadily until
retirement or near it. Meanwhile human capital is present value of remaining
lifetime pay, and shrinks steadily as approaching retirement and mortality leaves
fewer future paydays to discount. Most students of human capital including Ben-
Porath reason that self-investment must end when time left for recovery in higher
Chapter 2: Fast Forward 1/06/16 13
future pay runs out. So do I. The puzzle is how pay could rise while human capital
shrinks smoothly to zero.
This would not be a puzzle if we were speaking of oil wells whose oil might continue
to be pumped out at a steady or even rising rate until the well ran dry. We are
puzzled because pay is generally believed to equal and compensate work. Work
means the output of human capital. How could less capital steadily produce more
output, meaning creation as distinct from depletion of value, particularly if some
work is self-invested rather than marketed for pay? That would imply exponentially
rising productivity, meaning rate of return, and rising to infinity at the end.
Think about it. Strictly speaking, human capital is present value of future pay less
spending on future childhood nurture plus textbooks or tuition or job training
(collectively called “schooling” by Mincer) invested in human capital. Ben-Porath
knew that, as had others before, but reasoned that investment in anything must stop
when not enough time remains for recovery. I think so too. And I argue anyhow,
from observation rather than logic, that invested nurture and schooling
substantially end when we enter the full-time job market sometime in our twenties.
Then human capital in adulthood is essentially present value of expected pay, or
even less if Ben-Porath and I are wrong and nurture or schooling continues to the
end. When only a year of pay is left ahead of us, human capital at most is timediscounted
present value of one year’s pay. When one day is left, it is at most
present value of one day’s pay. Yet age-wage profiles show pay (wage) holding level,
or even rising, as human capital grades smoothly to zero. This is the famous agewage
puzzle. I’ll flesh out the same thought experiment later in what I call the
parable of the boss and her secretary.
Economists have recently proposed solutions which I see as farfetched. Possibilities
that human capital indeed grows more productive with age, or depreciates all at
once, seem implausible in each case and cannot begin to explain enough. I think
Becker hinted at the answer in 1964. Becker pointed out that job training at the
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employers’ expense is part of investment in human capital, and reasoned that
employers won’t pay it unless they expect eventual recovery with interest.
What Becker stopped short of saying is that the same is true of any investment in
anything by anyone. When we invest for our own benefit, we expect recovery by
ourselves. When we invest for the sake of others, we expect recovery by them.
Recovery means recovery of depreciation. Our parents would not have invested in
our human capital without expected recovery of our human depreciation by us, and
the young further invest the work of learning in themselves because they expect
that to be recovered with interest as well.
There is another proof which I call the deadweight loss rule. Capital of any kind is
present value of cash flow, meaning expected realizations in transfer or taste
satisfaction. Deadweight loss means decapitalization with neither. It follows that
deadweight loss, although a common reality, is implicitly unexpected. But human
depreciation, like plant depreciation, is expected from first investment. That rules
out deadweight loss, and makes human depreciation expected as cash flow by
elimination of alternatives.
Each proof is sufficient. The first expresses what I call the maximand rule: we
maximize risk-adjusted rate of return. Robert Turgot observed this in 1766. I’ll say
more about that in the next chapter. It takes little thought to realize that maximizing
risk-adjusted return begins with recovery of investment, and that this means
recovery of depreciation or amortization. We are depleted like the oil well, although
we create value too. The second proof needs only the assumption that human
depreciation is foreseen. It adds the specification that human depreciation is
realized in human cash flow. That turns out to mean that it is realized in pay. The
solution to the age-wage puzzle is that pay does not equal and compensate realized
work above. It compensates that plus human depreciation. I call this the “pay rule”.
Chapter 2: Fast Forward 1/06/16 15
The pay rule joins free growth theory and the Y rule as the three major surprises
promised in my title. Recovery of human depreciation in pay changes a lot of
equations. It does not impact public policy and tax laws as radically as free growth
theory, but I will argue that it impacts them enough. Even if it didn’t, it is probably
the most startling assertion in this book from an economist’s viewpoint. And
although I now know better than to claim originality for any idea in economics, this
one just might pass the test. If someone out there knows a precedent closer than
Becker’s, as I eventually found ones for what I had thought were my own free
growth and next generation theories, all the more fun in finding those unsuspected
precursors. (Next generation theory will be outlined soon.) And the two proofs
leave no doubt. I will add a few more as we go. It is never overkill to drive another
stake through the heart of entrenched misperception. Meanwhile we can already be
as sure of that expected recovery, not actual recovery, as of anything we know. The
arguments from the maximand rule (Turgot’s insight) and the deadweight loss rule
are unanswerable.
An analogy from something else we all know leads to the rest of my argument. Pay
over working careers is something like payments over the period of a decliningbalance
mortgage. Mortgage payments are partly amortization and partly interest.
Amortization is like depreciation, although without the same sense of physical wear
and tear behind it, and interest is like the worker’s output marketed to employers.
The declining balance is like human capital. Mortgage payments are almost all
interest at the start of the loan, when the declining balance is almost the whole loan
amount, and then gradually less interest and more amortization as the balance
shrinks. As the balance approaches zero at the end, the payment approaches all
amortization while the interest share approaches zero.
My depreciation theory, which we’ll come to soon, argues that depreciation follows
the same logic and the same math. I will argue, in the face of what has seemed to be
contrary evidence, that depreciation of both factors begins at zero and grows
Chapter 2: Fast Forward 1/06/16 16
exponentially to become all of cash flow at the end. This completes the explanation
of age-wage profiles as we see them. Pay is all human depreciation at the end.
What I Thought Once
Chapter 6 will compare accounting for human capital to accounting for a firm. Pay,
in this analogy, is the worker’s revenue. The firm deducts outside operating costs of
labor and supplies to leave gross realized output. The analogy for human capital
would be maintenance consumption enabling life and activity. But I don’t deduct
this in reaching the workers’ gross realized output (gross realized work) because I
take it as part of the net output we intend in itself rather than a cost in return for
what we intend. I see adult consumption as mainly Schultz’ pure consumption
exhausted from the universe of capital, including human capital, in satisfying our
taste for adult survival.
Opinion is divided here. Some economists have treated the maintenance
consumption that keeps workers going as new investment in human capital for the
sake of higher pay in future. Some in the 18 th century expensed it, like maintenance
in the firm, as a cost recovered in keeping up the worker’s revenue (pay) now,
rather than invested for later. I did that for years. I now treat it as recovered neither
in pay now nor pay later. Even though we couldn’t earn without it, I count it in pure
consumption exhausted in satisfying tastes for survival.
When I thought it was recovered in pay and work products, up to about five years
ago, I realized that human depreciation could not also be. There would be nothing
left for pure consumption except Mill’s “unproductive consumption” neither
replacing nor maintaining human capital. That would stand biology on its head.
Biology is precisely about replacing and maintaining us. Unproductive consumption,
for which there seem to be parallels in other species, is something biology has yet to
justify. It cannot be the unique taste satisfaction that behavior reveals.
Chapter 2: Fast Forward 1/06/16 17
I found a solution that seemed to make sense then. It was the exact opposite of what
I think now. If maintenance consumption were recovered in pay and work products,
as I now think human depreciation but not maintenance consumption is, then
human depreciation instead of maintenance consumption could be exhausted in
taste satisfaction! That seemed less macabre to me then. I looked for ways in which
human depreciation, hardly the biological end in itself, could somehow be its
measure. It was not unreasonable, I thought, to interpret human depreciation in
aging as the cost of survival. The old gag says that aging is not so bad when you
think about the alternative. Age-wage profiles could be explained, I thought then, as
recovery of maintenance consumption rather than of human depreciation in pay.
And I had those precedents from the 18 th century. I knew that Francois Quesnay
and the physiocrats, in Adam Smith’s time, had argued too that consumption could
be recovered in earnings. Mill could be interpreted that way, in his definition of
“productive consumption”, as could Piero Sraffa in a paper from 1960. I thought I
was on the right track.
What brought me to my senses was the thought experiment about a boss and her
secretary I mentioned earlier. Picture them together at the beginning of the last year
of human capital for each. The boss earns ten times as much. Human capital for each
is one year’s pay, or even less in the unlikely case that invested consumption
continues to the end, less one year’s discount. If pay measured work, rate of return
(work/human capital) would be something over 100% per year for each. It would
be even more in the unlikely case that some work remains unrealized (self-invested)
until the end. Yet their time preferences measured by return to their other
investments, say securities, is less than a tenth as much. This already states pretty
clearly that pay covers more than work.
In case there was doubt, go on to the beginning of the last day. Age-wage profiles
show that pay for each is about what it was a year before. Rate of return to each is