Samuelson on Economics and Behavior

Paul Solman: A final excerpt from my interview with Paul Samuelson about a decade ago. For this Christmas Day edition of Business Desk, Samuelson on where behavior and economics intersect.

SOLMAN: How much of human behavior does self interest explain?

SAMUELSON: I can’t put a quantitative figure, but, for the sake of argument, I’ll say half. Very hard to know which half. [LAUGHTER]

SOLMAN: So economics would explain about half of what we do.

SAMUELSON: Well, economics must study non-rational behavior, having to do with goods and services and allocation of resources. The agents who use informed rationality, over time, by Darwinian evolution process, gain more and more importance in the final decisions. I believe in the stock market, that’s one of my fields, that most people are irrational. And to be irrational, you can be irrational in so many different ways that, practically, the result is indeterminate. The minority who are rational have a disproportionate final influence on how things go, as, for example, what we see at the end of every bubble, including our most recent one [the dot.com collapse had just happened]. Gradually the value stocks, which did so badly compared to the growth stocks, are having a reversion toward the mean. History is written by survivors. [LAUGHTER]

SOLMAN: And so, even though rational self-interest only explains half of human behavior, ultimately, it has a disproportionate effect on what goes on.

SAMUELSON: Right. And, for people like myself, who have, quote, a humane interest, an ethical interest in economics, I constantly remind myself that the scarcest thing we have is altruism, and we must ration it extremely carefully because it’s so scarce, and that’s why, when one considers problems like rent control, where you’d like to sponsor Robin Hood in favor of the poor, you realize that the whole country of France had no residential building between World War I and World War II, primarily for the reason of permanent rent controls. That did not achieve the good life for the poor at the expense of the rich. Rent control created deadweight loss.

SOLMAN: A couple of specific questions, and then we’ll be done. The US has a trade deficit of $400 billion a year [2000, remember] That means people outside our country are taking in 400 billion dollars and giving us $400 billion worth of goods. What do they do with that money, that $400 billion?

SAMUELSON: U.S. capital formation, which has been pretty high in the ’90s, and very high in the late 1990s, is what is being financed by the savings of the rest of the world, generally poorer than ourselves, because our deficit on current account, chronic deficit, is their surplus, and they have been willingly bringing that to the American market. But we have to underline the very important point, America has become a very high consuming economy. Right now, except for paper stock market gains, we have a zero saving rate. How is it possible to have a zero saving rate and a strong positive capital formation rate? That capital formation rate is extremely important for the productivity of our workers and for the future of the baby boomers under the population shift. It’s possible only because of our current account deficit.

SOLMAN: Because they’re giving us the money.

SAMUELSON: THEY’RE giving US. Now what that means is that there’s a lot of capital formation taking place in the U.S., but it is increasingly foreign-owned capital, and these palm trees that have been planted, so they can be cut down in retirement and the nuts can be used to help retirement and help standard of living, they will go to the people abroad who own those things, not to the Americans who never saved to produce these things.

SOLMAN: Just as a technical matter, if they’re sending $400 billion worth of stuff to us, and we’re sending them $400 billion worth of assets, or dollars, broadly defined, what are they holding those dollars in? They’re holding them in bonds, they’re holding them in T-bills, they’re holding them in stocks?

SAMUELSON: Yes.

SOLMAN: Are they also holding them just in foreign reserves that don’t earn anything at all, I mean in central banks?

SAMUELSON: No, generally speaking, the assets that have come here, as recycled deficit, surplus recycled here, are earning higher rates of return than they would have earned in their own country, Japan being a notorious case, where the long-term rate of interest on Japanese bonds is like 2 percent, and they’re getting something like 6 percent here. But think of all these mergers that have been taking place, Daimler Chrysler, Deutschebank, and so forth. They acquiring equity ownership, and so the way I think of it is that this is a good place for capital formation to take place, so foreigners choose, instead of doing capital formation at home, to do it in the United States, and they maintain ownership.

SOLMAN: So they sell us stuff, they get our dollars, they take the dollars and they buy a stake in our country.

SAMUELSON: Yes. Part of the reason that they have as high incomes as they do is that they’re able to sell, through exports, so much to us at good, market-worthy prices. And they are choosing to do their capital formation here, so you must make a distinction between capital formation here and capital formation abroad, but you also must make a distinction between capital formation done here, owned by Americans, or capital formation done here, owned by foreigners, and that’s the big change since 1980.

SOLMAN: Because so much of it is done by foreigners.

SAMUELSON: Yeah, we’ve become a debtor nation. I don’t mean just on fixed-loan terms, but we own increasingly less abroad than is owned from abroad here.

SOLMAN: I made a flip calculation that if the stock market, if the NASDAQ had lost between them something like $6 trillion in the last six months or eight months, and foreigners own 7 percent of those assets, then they would have lost exactly the same amount of money that they funneled in this year, and it would be net even. In other words, they brought $400 billion, we went down $400 billion, and it’s a wash.

SAMUELSON: Right. Of course, they’re bringing in this money as a recurrent thing.

SOLMAN: No, one year’s worth, I meant.

SAMUELSON: And the loss, since March 10th, in the stock market, is not a recurrent thing.