Falling Real Interest Rates, Winner-Take-All Markets, and Lance Armstrong

In my previous post, I suggested that real interest rates are largely determined by expectations, entrepreneurial expectations of profit and household expectations of future income. Increased entrepreneurial optimism implies that entrepreneurs are revising upwards the anticipated net cash flows from the current stock of capital assets, in other words an increasing demand for capital assets. Because the stock of capital assets doesn’t change much in the short run, an increased demand for those assets tends, in the short run, to raise real interest rates as people switch from fixed income assets (bonds) into the real assets associated with increased expected net cash flows. Increased optimism by households about their future income prospects implies that their demand for long-lived assets, real or financial, tends to decline as household devote an increased share of current income to present consumption and less to saving for future consumption, because an increase in future income reduces the amount of current savings needed to achieve a given level of future consumption. The more optimistic I am about my future income, the less I will save in the present. If I win the lottery, I will start spending even before I collect my winnings. The reduced household demand for long-lived assets with which to provide for future consumption reduces the value of such assets, implying, for given expectations of their future yields, an increased real interest rate.

This is the appropriate neoclassical (Fisherian) framework within which to think about the determination of real interest rates. The Fisherian theory may not be right, but I don’t think that we have another theory of comparable analytical power and elegance. Other theories are just ad hoc, and lack the aesthetic appeal of the Fisherian theory. Alas, the world is a messy place, and we have no guarantee that the elegant theory will always win out. Truth and beauty need not the same. (Sigh!)

Commenting on my previous post, Joshua Wojnilower characterized my explanation as “a combination of a Keynesian-demand side story in the first paragraph and an Austrian/Lachmann subjective expectations view in the second section.” I agree that Keynes emphasized the importance of changes in the state of entrepreneurial expectations in causing shifts in the marginal efficiency of capital, and that Austrian theory is notable for its single-minded emphasis on the subjectivity of expectations. But these ideas are encompassed by the Fisherian neoclassical paradigm, entrepreneurial expectations about profits determining the relevant slope of the production possibility curve embodying opportunities for the current and future production of consumption goods on the one hand, and household expectations about future income determining the slope of household indifference curves reflecting their willingness to exchange current for future consumption. So it’s all in Fisher.

Thus, as I observed, falling real interest rates could be explained, under the Fisherian theory, by deteriorating entrepreneurial expectations, or by worsening household expectations about future income (employment). In my previous post, I suggested that, at least since the 2007-09 downturn, entrepreneurial profit expectations have been declining along with the income (employment) expectations of households. However, I am reluctant to suggest that this trend of expectational pessimism started before the 2007-09 downturn. One commenter, Diego Espinosa, offered some good reasons to think that since 2009 entrepreneurial expectations have been improving, so that falling real interest rates must be attributed to monetary policy. Although I find it implausible that entrepreneurial expectations have recovered (at least fully) since the 2007-09 downturn, I take Diego’s points seriously, and I am going to try to think through his arguments carefully, and perhaps respond further in a future post.

I also suggested in my previous post that there might be other reasons why real interest rates have been falling, which brings me to the point of this post. By way of disclaimer, I would say that what follows is purely speculative, and I raise it only because the idea seems interesting and worth thinking about, not because I am convinced that it is empirically significant in causing real interest rates to decline over the past two or three decades.

Almost ten months ago, I discussed the basic idea in a post in which I speculated about why there is no evidence of a strong correlation between reductions in marginal income tax rates and economic growth, notwithstanding the seemingly powerful theoretical argument for such a correlation. Relying on Jack Hirshleifer’s important distinction between the social and private value of information, I argued that insofar as reduced marginal tax rates contributed to an expansion of the financial sector of the economy, reduced marginal tax rates may have retarded, rather than spurred, growth.  The problem with the financial sector is that the resources employed in that sector, especially resources devoted to trading, are socially wasted, the profits accruing to trading reflecting not net additions to output, but losses incurred by other traders. In their quest for such gains, trading establishments incur huge expenses with a view to obtaining information advantages by which profits can be extracted as a result of trading with the informationally disadvantaged.

But financial trading is not the only socially wasteful activity that attracted vast amounts of resources from other (socially productive) activities, i.e., making and delivering real goods and services valued by consumers. There’s a whole set of markets that fall under the heading of winner-take-all markets. There are some who attribute increasing income inequality to the recent proliferation of winner-take-all markets. What distinguishes these markets is that, as the name implies, rewards in these markets are very much skewed to the most successful participants. Participants compete for a reward, and rewards are distributed very unevenly, small differences in performance implying very large differences in reward. Because the payoff at the margin to an incremental improvement in performance is so large, the incentives to devote resources to improve performance are inefficiently exaggerated. Because of the gap between the large private return and the near-zero social return from improved performance, far too much effort and resources is wasted on achieving minor gains in performance. Lance Armstrong is but one of the unpleasant outcomes of a winner-take-all market.

It is also worth noting that competition in winner-take-all markets is far from benign. Sports leagues, which are classic examples of winner-take-all markets, operate on the premise that competition must be controlled, not just to prevent match-ups from being too lopsided, but to keep unrestricted competition from driving up costs to uneconomic levels. At one time, major league baseball had a reserve clause. The reserve clause exists no longer, but salary caps and other methods of controlling competition were needed to replace it. The main, albeit covert, function of the NCAA is to suppress competition for college athletes that would render college football and college basketball unprofitable if it were uncontrolled, with player salaries determined by supply and demand.

So if the share of economic activity taking place in winner-take-all markets has increased, the waste of resources associated with such markets has likely been increasing as well. Because of the distortion in the pricing of resources employed in winner-take-all markets, those resources typically receiving more than their net social product, employers in non-winner-take-all markets must pay an inefficient premium to employ those overpaid resources. These considerations suggest that the return on investment in non-winner-take-all markets may also be depressed because of such pricing distortions. But I am not sure that this static distortion has a straightforward implication about the trend of real interest rates over time.

A more straightforward connection between falling real interest rates and the increase in share of resources employed in winner-take-all markets might be that winner-take-all markets (e.g., most of the financial sector) are somehow diverting those most likely to innovate and generate new productive ideas into socially wasteful activities. That hypothesis certainly seems to accord with the oft-heard observation that, until recently at any rate, a disproportionate share of the best and brightest graduates of elite institutions of higher learning have been finding employment on Wall Street and in hedge funds. If so, the rate of technological advance in the productive sector of the economy would have been less rapid than the rate of advance in the unproductive sector of the economy. Somehow that doesn’t seem like a recipe for increasing the rate of economic growth and might even account for declining real interest rates. Something to think about as you watch the Lance Armstrong interview tomorrow night.

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7 Responses to “Falling Real Interest Rates, Winner-Take-All Markets, and Lance Armstrong”


  1. 1 Benjamin Cole January 16, 2013 at 9:00 pm

    Okay, let me lead into this backwards, also with a bunch of speculative thoughts.

    1. When General MacArthur ruled Japan , and before that the Philippines, he instituted…land reform.

    Really? Yes. MacArthur was a pinko-leftie?

    Well, I don’t think so. Part of what he did was fighting communism.

    But let’s ask the question: What happens when so much wealth is locked up in small groups, and they don’t rally see the need to do much, as they are already rich? Why should have the old oligarchs in old Japan or the Philippines done anything except live high and chase pretty girls?
    So can concentrations of wealth–the winner take all picture–depress growth?

    2. Suppose today you have wealth locked up in small pockets, and they can just decide to sit on the sidelines for a long while until things get better? They are not starving.

    3. Add on: What if an economy passes upwards through a point where most people can start saving, and so do so. Suddenly, there is a lot more capital than before. Does that mean lower rates?

    If capital is no longer scarce, but is now abundant—a new phase in history—should we not expect lower rates and lower returns, especial on passive investments? Supply and demand?

  2. 2 Blue Aurora January 16, 2013 at 10:01 pm

    Commenting on my previous post, Joshua Wojnilower characterized my explanation as “a combination of a Keynesian-demand side story in the first paragraph and an Austrian/Lachmann subjective expectations view in the second section.” I agree that Keynes emphasized the importance of changes in the state of entrepreneurial expectations in causing shifts in the marginal efficiency of capital, and that Austrian theory is notable for its single-minded emphasis on the subjectivity of expectations. But these ideas are encompassed by the Fisherian neoclassical paradigm, entrepreneurial expectations about profits determining the relevant slope of the production possibility curve embodying opportunities for the current and future production of consumption goods on the one hand, and household expectations about future income determining the slope of household indifference curves reflecting their willingness to exchange current for future consumption. So it’s all in Fisher.

    A brief comment invoking John Maynard Keynes here…

    If you read the CWJMK, you will find a statement by J.M. Keynes regarding Irving Fisher. The context, IIRC, was in correspondence with another person, but I forget who. What I do remember is that J.M. Keynes DOES describe Irving Fisher as one of his “great-grandparents in errancy”. (J.M. Keynes also says something similar with regard to the Swedish economist Knut Wicksell.)

    I believe that Irving Fisher and J.M. Keynes had cordial personal relations. I also believe that J.M. Keynes and Irving Fisher would have agreed on the importance of the Quantity Theory of Money, despite changes in their economic thought over the course of their lives.

    My evidence for this?

    Well, apart from Keynes’s citations of Irving Fisher’s works in earlier books such as A Tract on Monetary Reform and A Treatise on Money, I would like to point people to Book V of The General Theory of Employment, Interest and Money.

    Book V consists of ‘Chapter 19: Changes in Money-Wages’, ‘Appendix to Chapter 19: “Professor Pigou’s “Theory of Unemployment”‘, ‘Chapter 20: The Employment Function’, and ‘Chapter 21: The Theory of Prices’.

    Chapter 19 and its appendix includes mathematical equations that compare Keynes’s supply-side to Pigou’s supply-side (see Chapters 8 to 10 of The Theory of Unemployment by A.C. Pigou, published in 1933).

    This sets one up for Chapter 20. Multiple references to Chapter 20 can be found on throughout Keynes’s magnum opus (for example, in a footnote in ‘Chapter 3: The Principle of Effective Demand’, Keynes warns that Chapter 3 is merely an introduction to the more elaborate modeling found in Book V’s Chapter 20).

    When you reach Chapter 20, you will find the following statement on Page 285: “This equation is, as we shall see in the next chapter, a first step to a generalised Quantity Theory of Money.

    At that point, go to Pages 303 to 306. There, you will see in Chapter 21, Keynes’s incorporation of the QTM into a more comprehensive theoretical framework with practical applications.

    For more scholarly references, I suggest looking for these articles by Dr. Michael Emmett Brady…

    http://www.hetsa.org.au/pdf-back/25-A-13.pdf

    http://www.hetsa.org.au/pdf-back/24-A-4.pdf

    http://www.hetsa.org.au/pdf-back/21-A-4.pdf

    Here are articles by scholars who support Dr. Brady’s findings…

    http://www.scielo.br/scielo.php?pid=S0101-41612010000400005&script=sci_arttext

    https://docs.google.com/file/d/0B35cYfE6phNaSElQeW1xZFB5aW8/edit?pli=1

    And for a review by Dr. Michael Emmett Brady of an article published in International Advances in Economic Research, please see the following link. Dr. Brady commends their work, and makes a minor correction of a statement in that article.

    http://www.amazon.com/review/R2RJA6831Z2BA6/

  3. 3 Bill January 17, 2013 at 6:21 pm

    If I win the lottery, I will start spending even before I collect my winnings.

    A very interesting fact is that victims of swindles rarely, if ever, start spending before they collect their winnings, suggesting they may not be victims at all and that something else is going on entirely.

  4. 4 Becky Hargrove January 18, 2013 at 7:05 am

    Winner take all markets in skills augmented by technology is a natural outcome in monetary terms, just as you described, for value in exchange activity. However the only way this system can be realistically maintained is to eventually operate alongside a value in use system of skills that measure relative time production relations, rather than the logical conclusions of margins and economies of scale. Otherwise, we all grow up dreaming of what we want to do with our lives, and wind up watching the winners carry on all the (measured) economic activity on electronic screens.


  1. 1 Falling Real Interest Rates, Winner-Take-All Markets, and Lance Armstrong | fifthestate.co | Scoop.it Trackback on January 17, 2013 at 6:35 am
  2. 2 The Social Cost of Finance « Uneasy Money Trackback on January 21, 2013 at 7:58 pm
  3. 3 Food for thought: real interest rates and the changing nature of the economy. « Economics Info Trackback on February 13, 2013 at 11:03 pm

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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