The first in a special 3-part series on antitrust law. In the wake of the approved merger between giants AT&T and Time Warner, Kate and Luigi talk with a leading expert, Carl Shapiro, about the evolving concept of consumer welfare and whether antitrust law needs to change with the times.

Do central bankers have too much power? Paul Tucker, a former official at the Bank of England during the 2008 financial crisis and author of the new book 'Unelected Power,' explains to Kate and Luigi how technocratic hubris can imperil democracy.

Kate: So, Paul, why are you trying to impose constraints on yourself?

Paul Tucker: I believe in democracy. It’s a precious—

Luigi: This makes him even more unique, a central banker who believes in democracy.

Kate: Hi, I’m Kate Waldock from Georgetown University.

Luigi: And I’m Luigi Zingales at the University of Chicago.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Kate: Should I introduce Paul?

Paul Tucker: Only use the Sir once, but only once. Okay?

Luigi: Sir Paul.

Paul Tucker: Yes. Luigi carries this off with the appropriate derision that a European knows how to deliver.

Kate: Okay, I had a plan for the Sir. Ahem, today we’re joined by Sir Paul Tucker, an economist who is the former deputy governor of the Bank of England from 2009 to 2013. He’s now a fellow at Harvard’s Kennedy School and Harvard’s Center for European Studies. He’s also the first knight I have ever spoken to, which has me swooning. He has a new book, Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. So, welcome to the show, Paul.

Paul Tucker: Well, thank you very much for having me here.

Luigi: Paul is unique in many dimensions, but I think one I want to share with my listeners: generally retired, important figures like Paul write memoir books that are pretty boring. They sell very well. They make them rich, but they’re pretty boring, and they tell the gossip of what was going on when they were in power. Paul has written a book which is exactly the opposite of this; it is a scholarly book where he reflects about the role of central banks today. He’s the only central banker who would like to limit the power of central banks.

Kate: So, Sir Paul, what prompted you to write this book in the first place?

Paul Tucker: Two things, and they came together. The first was, I was intimately involved, and that’s understatement probably, in designing the powers that were granted to the Bank of England after the financial crisis. It became a much more powerful institution. But actually, we leant against, I leant against some powers that some people wanted to give us. We argued for careful constraints around the new powers that we were given: supervisory powers, regulatory powers, all sorts of things.

In the back of our mind was a desire not to be too powerful, to be legitimate. I wanted an opportunity to write down what lay behind that, which was things like the values of democracy, and the rule of law, and constitutionalism. Not the kind of things that feature in discussions about central banking, but I absolutely promise were in my mind, and I think in Mervyn King’s mind, the then governor, as we navigated all of that.

The second thing was the kind of ... This came to me really while I was writing the book, I started writing the book in 2014, is the debate about technocracy versus populism. I just ended up believing that technocracy needed to retreat a bit, both for its own sake, and, actually, because there was a risk of people saying, “Well, too much, too much is in these unelected hands.”

The book in some senses is about central banking, because central bankers are so powerful today. I was lucky enough, privileged enough to have some of those powers. But it is also, I don’t think of it as a book that’s about economic policy. I think of it as a book that is about democracy, and power, and populism. But not one of the books that attacks populism, or attacks technocracy. But it’s about technocracy from the inside, and where would one technocrat take technocracy? Well, shrink it a bit.

Luigi: In your book, Unelected Power, you make some very interesting remarks and comparisons with the judiciary and the military. One of my favorite lines issued by Clemenceau, who was prime minister in France during World War I, is that, “War is too serious a matter to let generals run it.” Can you say the same thing about central banks?

Paul Tucker: Not quite, but I think that’s exactly the right way of thinking about it. I should’ve used that quote in the book. The reason you can’t ... it’s not just that you can’t leave war to generals, the generals can turn on you. Finding a place for the military in our societies was a huge thing for centuries, because they are capable of taking over. They have in some countries. One of the great achievements of our societies is avoiding that.

Where this matters for central bankers is when you get absolutely to the edge of their powers, but they could still save the world. They could still make things better. But you haven’t provided for it in law. Or if it is provided for in law, no one ever remotely contemplated it. Let me give you an example. The European Central Bank saved the euro area in 2012, and it acted within its legal powers. The constitutional court later determined that. But it certainly acted in a way that no one ever had thought it could.

I think they did consult the German government. I think they should’ve gone to the Council of Ministers, which is essentially the governing body of the EU—in intergovernmental mode, there’s an important constitutional nuance there—and said, “Do you want us to rescue your project, your country, your jurisdiction,” rather than just assume it? That may sound like a formal thing, but it amounts to ... it’s consistent with our values that the unelected people should not take over. I certainly ... you can’t have central banks going beyond their legal boundaries. If they reach their legal boundaries, then it’s over to the legislature. It’s over to the fiscal people.

That might sometimes ... when I say this in this country, sometimes people will say to me, “But then the people would’ve been worse off. Of course, the Fed should always come to the rescue, and they’re going to get criticized.” I understand that sentiment. But there’s a trade-off between welfare today, and whether people accept the system of government. This is a judgment. The judgment about what to do when you’re at the boundaries, those judgments must be made by elected people, not by unelected people.

Luigi: The mood today is exactly in the opposite direction. You certainly belong to the group of people called experts. There is an increasing tendency of experts to say, “You should let us do our job, because you people don’t understand what you’re doing.” Certainly, a lot of people don’t understand what central banks and bankers do. “You people don’t understand what we’re doing, so we need to operate without the constraint of you politicians who don’t understand what we’re doing.”

Paul Tucker: I mean, what you say is true, but it’s not the whole truth. There are other people that say, “Well, we’ve had enough of being ruled over by people that we didn’t vote for, and can’t vote out.” We live, around the western world, in complex times. I absolutely don’t just mean since the presidential election here, or the referendum in the UK, and the various elections in continental Europe.

Part of the reason people are ... Let me put it this way. The more and more we put into the hands of so-called technocratic experts, the more we take a risk that there will be a backlash. So, I deliberately put it just through the voice of the technocracy itself. Part of my message would be, the technocracy needs to retreat a bit, if only out of self-interest.

Now, I actually think there’s a deeper principled reason for retreating as well, but if only out of self-interest, technocracy ought to back off a bit, and not claim that it has the answer to every set of questions, because it doesn’t.

Kate: All right, so I’m pretty sure ... I’m 100 percent positive that I am the lowest common denominator amongst the three of us when it comes to knowledge of what central banks do. So, I’m going to start out with my impression of what the Fed does. Okay? It’s as follows. It sets monetary policy. By that I mean it adjusts interest rates so that if, say, employment is low, and prices are low, or inflation is low, then the Fed will cut interest rates, so that it’s less attractive to save, people will go out and spend more, and that will boost the economy, therefore raising employment.

The opposite may also be true. If there’s high inflation and also high employment, the Fed may raise interest rates, and people will therefore cut back on their spending, and hopefully bring inflation down. Is that a fair characterization of monetary policy?

Paul Tucker: Yes, but it’s quite a few steps down the road of what a central bank is. A central bank is an institution of the state of government that issues money. It’s a special kind of money. It’s the money that we pay our taxes with, ultimately. It is the money that people are obliged to accept in settlement of payment for the goods and services that we buy, consume, et cetera.

This is an extraordinary thing. The state creates this money, and it says, “We will give this money a special legal underpinning.” If you and I ... if I bought something from you, you and I would settle, not in that money probably, certainly if it was a large amount. We would settle. There’d be a transfer from a deposit, my deposit account with a commercial bank, to a deposit account with your commercial bank. But those banks would settle amongst themselves in the money of the Federal Reserve. Once you’ve created this money, you have to decide how much of it to have out there in the economy, or what price to put on it. That’s where what you say comes in.

Luigi: But Paul, you said correctly that most of us do not transact with that money. We transact with deposits. Why in the 21st century, and there are, of course, a lot of reasons in the 18th and 19th century, but why in the 21st century do we actually let banks be in control of the creation of most of the money? Today when I deposit my money in the bank, I get zero percent. When my bank deposits at the Fed, it gets an interest. Why do they have access to an interest and I don’t?

Paul Tucker: I think this is a great question. I think there is a good answer. Imagine that we all, all the population, had accounts with the Federal Reserve in this country, with the Bank of England in the UK, with the European Central Bank in continental Europe. We would hold balances with it. I want to suggest that if that was the case, that as well as being depositors with the central bank, when times got hard we would expect to be able to borrow from the central bank as well. We would want an overdraft account from the central bank.

It seems to me the most important thing in political sense that commercial banking does, is it gets the state out of determining the allocation of credit, who gets loans, and who doesn’t. Now it may well be with the new technology that there will be a way of solving for us all being able to hold money issued by the Federal Reserve, without having accounts at the Federal Reserve, which could be used to borrow from the Federal Reserve. But I would be very nervous about what started off as a monetary initiative ending up as a credit initiative. There’s a long history in this country, by the way, of people wanting to change the monetary system, and then when politicians get a hold of it, actually turning it into a policy about credit and lending.

Luigi: Why not use prices to allocate a given quantity? I think that if the deposits are safely at the Fed, and … you can then decide on where to invest them based on prices.

Paul Tucker: This is a model which is trying to separate the monetary system from the capital markets essentially.

Luigi: Yeah—

Paul Tucker: No, no. That might work eventually. But so long as you find small businesses, or people who can’t access the capital markets, which is how things have been through the 20th and first part of the 21st century, then you will have some kind of banking-type institution, public or private, I prefer private, that makes loans to them. I think if we all have accounts with the Federal Reserve, the next stage, it

wouldn’t happen in the first week ... over the years, as decades passed, people would say, “Well, actually, the Federal Reserve should get into lending to parts of the economy as well.” Be careful what you wish for.

Kate: All right, so in addition to what we’ve been talking about, the Fed also has other roles, though. Right? I mean, we’ve mentioned private banking. The Fed monitors, and, to some extent, does have control over private banks.

Paul Tucker: What I think central banks should be doing is ensuring the resilience of the biggest banks. Resilience comes in two forms, actually. For small or medium-sized banks, if they fail, the deposit insurer pays out to the insured depositors, regular people. That’s fine. I don’t think anyone should be in the business of trying to ensure that small or medium-sized banks are so safe that they never fail.

Now, actually, everybody made the mistake of hoping that the biggest banks would never fail. That, of course, wasn’t true. They did fail, so we can’t rely, even for the biggest banks, on supervision, the Federal Reserve, people in Europe, doing this so well, and the banks being so well managed that they will never fail. That failure will happen again. We need to ensure that that can happen in a more or less orderly way, so that the politicians aren’t faced with a stark choice between fiscal bailout of the banks, and the bankers, and the bondholders, and the equity holders in the banks on the one hand, or, on the other hand, complete chaos.

Kate: But now I’m a little confused, because who is the lender of last resort? Is it the Fed, or the FDIC?

Paul Tucker: Yeah, sorry. The debate about these issues in the United States isn’t terribly good. That’s because somehow the perception has grown over the years that the central bank, the Federal Reserve, is a lender of last resort, is a bailout facility. It’s not. You should only use the lender of last resort, creating money and providing liquidity, to a bank that has got liquidity problems, but not to a bank that has got deep, deep solvency problems.

Now, of course, in a world where you can’t resolve a failed bank, a fundamentally bust bank in an orderly way, the lender of last resort and their political counterparts in the administration and Congress get tempted to reinvent themselves as a bailout mechanism. Actually, the Dodd-Frank Act, and the work the FDIC has done with others around the world kind of protects the Federal Reserve from that temptation in the future. So, the Fed is the lender of last resort, but the FDIC enables the Federal Reserve to stick to its mission, and not get into the fiscal business of bailing out banks.

Luigi: We are approaching the 10-year anniversary of the famous Lehman weekend. Even today, we’re discussing whether Lehman was solvent or insolvent. Had you been chairman of the Fed, would you have lent to Lehman, and what would your policy suggest in that case?

Paul Tucker: With today’s powers, you’d put Lehman into resolution. It would go through ... For listeners that are familiar with the jargon of the Dodd-Frank Act, Lehman would today, I hope, go through what is called Title II resolution. What would happen is that the equity holders would be wiped out, consistent with capitalism and market economy. The bondholders would take a big hit, with part of their investment converted into equity. The authorities now have the powers to do that, and—

Kate: I’m so excited to be talking about bankruptcy on the podcast for once.

Paul Tucker: Bankruptcy, good mechanisms for handling bankruptcy, are completely integral to a successful market economy, capitalism.

Kate: I couldn’t agree more.

Paul Tucker: If someone said to me, and I think I’m on the record when I was in office saying this, if someone said to me, “If you could lift one thing from the United States’ economic policies and institutions, and take it into Europe,” it would be the Chapter 11 bankruptcy procedures that you’ve had in this country, and have served you very well, because it allows failure. We’re talking now about nonfinancial companies. It allows failure to happen without the earth quaking, and that’s a kind of ... capitalism is about success and failure, and somehow getting to good places in slow motion.

Kate: Paul, I said that because I do research on Chapter 11, so I’m always trying to give it a plug.

Paul Tucker: I didn’t know that.

Kate: In any case, how would you have resolved Lehman if Dodd-Frank hadn’t existed?

Paul Tucker: Hadn’t existed—

Kate: Since it didn’t—

Paul Tucker: I’m not going to answer that question, because I wasn’t there. I mean, you have to be ... I’m not going to rerun history when I wasn’t in the room, and I didn’t have the information. I mean, it’s well known that the UK regulator, speaking loosely, didn’t permit one of the UK banks to buy Lehman. The reason for that, broadly speaking, was because the UK authorities weren’t convinced that Lehman wouldn’t bring down the combined entity, and transferring a problem from the United States to the United Kingdom.

I think that the central banks need to articulate and publish how they would go about assessing fundamental solvency in a crisis, rapidly. When I first said this to my old tribe, my old community, the response from many, not all, the response from many was, “This is going to be almost impossible. All these things happen very quickly. It has to be improvised.”

Well, I can remember when monetary policy used to be improvised. Now, your listeners might be slightly surprised, the monetary policy process that the Federal Reserve, or the ECB, or the Bank of England, it’s like a General Motors, Ford, factory production process, with the hands doing the work, typically got PhDs or master’s degrees in economics. But they are part of a very structured process that is repeated again and again, because it happens every six weeks. It’s a lot of resources as well. I see absolutely no reason why the same kind of structure couldn’t be put in place.

Luigi: Why has so little attention been put into this so-important topic?

Paul Tucker: I don’t have a complete explanation for that. I think partly because during the 1990s and into the 2000s, people started to identify central banking just with monetary policy, and with a certain type of academic macroeconomics. Also, because there hadn’t been a need in the advanced world for the lender of last resort to act as the lender of last resort for a long time. Except that even what I just said isn’t completely true. I deliberately misspoke, because it had been used in Japan.

One of the things that I think is inexplicable, and doesn’t shine a happy light on North America or Europe, including Britain, is central banks had been acting as lender of last resort in emerging-market countries, and even in Japan, but somehow that was because of something special about those countries. It couldn’t possibly happen to us. Then it did. Of course, one of the great lessons is that anything that can happen eventually will, and you should prepare for the big things.

Kate: One of the functions of the Fed is to oversee financial stability. You’ve mostly been characterizing that as, at least how I interpret it, their lender of last resort functions. But actually, it seems to me, overseeing financial stability is a much broader mandate. In some sense, what we should be worried about is the power of the Fed beyond just their lender of last resort responsibilities. Do you think that those are areas we should be worried about?

Paul Tucker: You’re right. I mean, the lender of last resort function, and the parallel FDIC resolution function, is for when things have gone wrong. But you also need policies to reduce the probability of them going wrong. That’s the regulatory and supervisory function of the Federal Reserve. There’s something big going on here, particularly with regulation. In that, what does a regulator do? A regulator issues rules that certain people or businesses are obliged to obey, and can be punished if they don’t.

Although everyone talks about the biggest thing the Federal Reserve does is monetary policy, and it is a very big thing to do, it’s a very big thing for anybody who isn’t elected to issue legally binding rules, which can be enforced with the coercive power of the state. Where that takes me, and what I argue in the book, is that for an institution that’s insulated from day-to-day swirl of politics, in my view, the function of the Fed or the Bank of England, ECB in this area, should be just to ensure that the banking system is resilient: there will be boom and bust, but when the bust comes, the financial system doesn’t collapse, and that it can continue to carry on providing the core services of payments, so we can go shopping, and credit, so that we can invest, and insurance, and risk transfer.

Then you say, “Well, how resilient should the financial system be?” You say, “Well, actually, that’s a job where you need to involve Congress, because the more resilient you make the system, maybe there is a trade-off with long-term growth.” The truth is that no one knows.

My own view is that the US financial system is quite a lot more resilient than it was a decade ago, but should be more resilient still. But I actually think that ultimately that judgment should be made by people who are elected. Then the Fed and others should get on with the job of implementing it.

Luigi: I don’t know in Britain, but in the United States, the perception is that Congressmen are not that sophisticated to make many of these decisions. How do you answer that kind of criticism?

Paul Tucker: I’ve heard this for years, but whenever I have conversations with people in government here about that, the time horizon tends to be, “We couldn’t persuade them now,” or, “We couldn’t persuade them this year.” Well, of course, that’s true. But what about over five years, or 10 years, or 20 years? These are big issues. A curiosity, by the way, of the United States, is the way the Fed is referred to as the Greenspan Fed, the Volcker Fed, the Bernanke Fed, the Yellen Fed. I mean, in a sense, those are just words that don’t matter, but I’ve worried slightly that the institution doesn’t have a long enough horizon about the deep institutional ... I mean, it’s a terrific organization at dealing with policies used today. But somehow persuading Congress of certain things, you need to have a timeline of 10 years or 20 years, so you won’t finish the work yourself. You need to hand it on to your successors. That’s what it is to be an institution, the orders passing through.

Luigi: To what extent, the resentment that is widespread, particularly in the United States, is a reflection of a sense, as you indicate in your book, that you can’t get rid of some of those people? That many of the decisions that matter for our lives are not taken by elected officials, and we cannot get rid of them?

Paul Tucker: Part of it is historical here, because there wasn’t a Federal Reserve. There were great debates about the First Bank of the United States, and the Second Bank of the United States. But I think there are two other sources of broad concern that come and go. One is this business of, does it bail out Wall Street? We’ve talked about that, but it’s really, really important that when banks and dealers are fundamentally bust, that the equity holders lose money, that the bondholders lose money, that they should not be bailed out.

The third thing is, is it clear enough what they’re expected to do? We don’t live in 1950. In today’s world, it’s really important for holders of unelected power to encourage politicians to set them clear objectives. Then, if they don’t, if politicians don’t set them clear objectives, to articulate what they will be trying to do with the powers that they’ve been given. This is trying to bind yourself in, and it’s trying to make yourself comprehensible to the public. I think that the Federal Reserve chair went on television during the crisis. I mean, that was obviously an important initiative.

In Britain, the central bank governor and others we’ve had have been going on television for some years. I hope, think, carefully, not in a way that competed with the politicians.

But if you’re invisible, if you hold so much power and you’re invisible, people can be alienated by that. So, on the whole, I think, get out there and explain. Explain in as simple language as you possibly can, so—

Luigi: This is the opposite of what Greenspan was saying. Greenspan was famous to say to a journalist, “If you have understood me, I misspoke.”

Paul Tucker: Well, I can’t remember the exact context of the question, so maybe this was a question which he just didn’t want to answer at all. But if one takes it out of context, would that be a good recommendation for central bank communication? No.

Kate: Paul Tucker, author of the new book Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. Thanks so much for being on.

Paul Tucker: It’s been a real pleasure to be here.

Should a kidney be sold to the highest bidder? Luigi and Kate debate Nobel-winning economist Al Roth whose algorithm for kidney transplants has saved more than 6000 lives. Roth says matching markets could be used for everything from online dating to the global refugee crisis.

Luigi: How many lives did you save?

Al Roth: Well, so first of all, that’s hard to know, but so far there’ve been about 6,000 transplants arising through kidney exchange in the United States.

Kate: Hi, I’m Kate Waldock from Georgetown University.

Luigi: I’m Luigi Zingales at the University of Chicago.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Kate: On today’s episode, we’re going to interview a Nobel laureate who saved 6,000 lives.

Luigi: Kate, I thought we were running a economics podcast. We’re interviewing a doctor?

Kate: No, we’re interviewing Al Roth, a Nobel laureate in economics who saved at least 6,000 lives through his mechanism to allocate kidneys.

Luigi: Most people outside of economics think that economists only study the behavior of markets, but economists study many things including the way markets should be designed. And not only a traditional market like the stock markets or the oil market, but also markets where there’s not a price.

Kate: When you think of the term markets, you usually think about money exchanging hands, but even in advanced economies, there are markets without money either because people just don’t want to use money or because it’s not allowed. Think about the dating market, for example. Right? People are trying to match up. You’re trying to, in some sense, engage in a transaction that works out for you, but most of the time there’s no money involved even though, I guess, there are dating sites where you can pay, or you can pay a matchmaker, or whatever. But anyway, this isn’t what I’m getting at. On today’s episode, we’re talking about markets where money is explicitly banned. In some cases, these can be what society considers repugnant transactions. Often when it comes to medical practice, such as the exchange of organs, money is explicitly outlawed. Obviously, this makes sense for an organ which you can’t live without—for example, your heart—but actually people have two kidneys, and you can live without a kidney. Yet we’re still not allowed to put a price on a kidney.

Luigi: Now, people might question and say, “Wait a minute. If there’s no price, there is no market. What kind of market are we talking about that hopefully leads to a better allocation?” The challenge in this particular market is there are people who are willing to donate organs. Generally, they try to donate organs to people they care about, but these people are not necessarily compatible, and so you have to find another pair in order to do the exchange. Sometimes you want to do it even more complicated with three pairs of organ/recipient donors.

In a normal market where prices are allowed, if I am a very difficult guy to match, I can start to offer the highest price. This naturally will bring the people to me to try to transact, and this guarantees that the maximum number of possible transactions will take place.

In a market without prices, we tend to be indifferent between two transactions because no consideration is paid. If I swap my kidney with Kate’s boyfriend or if I swap my kidney with my cousin, that is completely indifferent to me. However, because of difference in compatibility, if I swap the kidneys directly with Kate’s boyfriend, I might prevent my cousin to match with somebody else. The complication of the algorithm is to find a way to match pairs that maximizes the number of transplants that can take place. Today Al Roth is going to explain to us how his mechanism saved 6,000 lives.

Kate: Before the innovation that you introduced to the kidney market, can you talk about some of the reasons why it was hard to find a kidney?

Al Roth: Well, the main reason it’s hard to find a kidney is there’s a shortage of transplantable kidneys. This morning, and every morning lately, there are 100,000 people waiting for deceased-donor transplants in the United States, but we only do about 13,000 a year. The main reason it’s hard to get a transplant is there aren’t enough organs. We also can use living donor kidneys because healthy people have two kidneys and can remain healthy with one. There also, there aren’t enough donors, but the additional problem is that even if someone loves you enough to give you a kidney, you might not be able to take their kidney because kidneys have to fit well with your own physiology. That’s where kidney exchange came from. Sometimes you are healthy enough to give someone a kidney, but you can’t give it to the person you love who needs a kidney. I might be in the same situation. I love someone enough to give them a kidney, but can’t give them my kidney, but maybe your patient could use my kidney, and my patient could use your kidney. That’s where kidney exchange comes from.

Luigi: Before we go into the algorithm you devised, in most markets when there’s not enough supply, prices go up, and you have more supply.

Al Roth: Yes.

Luigi: At least that’s what we think in economics. Why this is not a case in this market?

Al Roth: Well, in the United States, and everywhere in the world except in the Islamic Republic of Iran, it’s illegal to pay for a kidney for transplant.

Luigi: That’s interesting, so Iran is more a market economy than the United States?

Al Roth: Yes. Yes, and it’s the only one. You would be less surprised if I said to you, “All of the countries we know of work in a usual way, but the Islamic Republic works differently.” But that’s not the case. One of the things I’ve been led to study through my work in kidney transplantation is what I call repugnant transactions. Transactions that some people would like to engage in, but other people think that they shouldn’t be allowed to. Of course, these are most interesting, most worth studying, if there aren’t obvious negative externalities; we’re all, as economists, we’re already good at understanding markets that some people would like to engage in and other people think they shouldn’t if they have big externalities that harm other people.

With kidneys, that’s not the case or not obviously the case. I think it mostly has to do with worrying about somehow exploiting vulnerable people, the idea that rich people would buy kidneys from poor people and maybe the additional idea that only rich people would be able to get transplants because the price would be driven up. Of course, those are market design issues, but it remains the case that the supply of transplantable organs is much less than the demand and the law requires that the price be zero, that kidneys have to be a gift.

Luigi: So everybody’s making money in the transaction except the donors.

Al Roth: Yes. In fact, the donors may lose money. If you loved me enough to give me a kidney, you would have to incur some expenses. You’d have to come to California probably before the surgeries for some tests. You would have to get a hotel room. You’d have to fly to California, you’d have to get a hotel room a couple of days before your nephrectomy and maybe a couple of days after. You might miss some work. The law actually allows the expenses a donor incurs to be repaid, but it’s very hard in the United States and elsewhere, it’s very hard to repay them.

Luigi: Do you know anything about how in Iran it works? Does it work better in Iran with the price?

Al Roth: It’s a little complicated in Iran. There are some studies of the market. It’s a legal market in Iran, but it’s not one that people are proud to participate in, so there’s some stigma associated with selling a kidney in Iran, which suggests to me that the market isn’t working as well as it should.

An example that the late Gary Becker used to like to give about this was he said how about the transition in the United States from a conscription army to a volunteer army, which of course happened around the end of the Vietnam War. What Gary used to say was that, well, Gary used to say, this is a natural analog for paying kidney donors. What I recall from that time when that debate was going on was there was some concern that American soldiers would come to be regarded as mercenaries because they were going to be paid a wage like a regular job for being soldiers. That hasn’t happened. People are proud to be soldiers. When someone runs for the Senate in the United States, it’s their campaign that emphasizes their military service. When we board airplanes, we’re invited to board after serving soldiers. People are proud to be American soldiers, even though soldiers are paid.

Of course, making something legal isn’t the same as making it unrepugnant. Prostitution is legal in Germany, for example, but I don’t think anyone runs for political office in Germany saying, “You should vote for me because when I was young, I was a sex worker.” It’s still a repugnant market. My sense is that’s going on in Iran with kidney selling. I don’t know a whole lot about that. There are going to be papers quite soon by Mohammad Akbarpour and his colleagues on this subject, but there’s something that although it’s legal hasn’t made it honorable.

Kate: Yeah, I think maybe a closer analogy for the US would be that of plasma donation. Right? A lot of people who need money have to donate their plasma, but you don’t hear people talking about it all the time because it’s not exactly a badge of honor.

Al Roth: Right, and paying for plasma is illegal in lots of places. Canada is debating its laws as we speak. Some of the argument in Canada is that it would be immoral to pay people for plasma and besides, you don’t have to because you can buy all the plasma products you need from the United States. We turn out to be the Saudi Arabia of plasma, and there are-

Kate: Good for us.

Al Roth: ... important medical products like interferon and albumin that are derived from plasma, and we’re giant exporters of those medical products.

Kate: In addition to the requirement that prices have to be zero, are there other constraints legally in the United States to exchanging kidneys?

Al Roth: Well, the main legal issue for living donation is that you can’t pay, so the donation has to be free. Incidentally, of course, kidney transplantation is expensive, as you say. Everyone else in the supply chain is paid. It’s a special program in Medicare. So there are only three entryways into Medicare: you could be over 65, you can be disabled, or you can have kidney failure. Medicare covers the costs of kidney failure for everyone. It’s 7 percent of the Medicare budget. It’s the biggest single program in Medicare. If you have private insurance and you have kidney failure, your insurer will be responsible for you for the first 33 months, after which you become Medicare-eligible. If you don’t have insurance, you’re already Medicare-eligible for kidney failure. It’s a giant American program. Dialysis is the big part of it. Dialysis is much more expensive than transplantation and also not a cure at all. It’s a really good thing for people who have kidney failure and for the American medical system in general, even just financially, it’s a very good thing for someone to get a transplant.

Luigi: Can you explain to our listeners, what is your contribution as an economist in setting up this matching market?

Al Roth: Well, exchange is something that economists study, so the economists, my colleagues and I, so Tayfun Sönmez, and Utku Unver, and Itai Ashlagi, and other of my close analytical colleagues, we certainly didn’t invent kidney exchange. A few were done around the world starting in the 1990s. The first one’s actually in South Korea. There was one in Europe in early 1999 that was met with great repugnance, incidentally. The first kidney exchange in the United States was conducted in 2000, and I had been in a, just a rhetorical way, talking to my class about kidney exchange for some time because I would present a paper by Shapley and Scarf that was published in Volume 1, Number 1 of The Journal of Mathematical Economicsin 1974. They had a model of trading houses with no money, trading a discrete, indivisible good without using money, and my students would say to me, “We use money when we trade houses, you knew that, didn’t you?” I would have to admit that I did know that. I was at the University of Pittsburgh at the time, where a lot of transplants were done, so I started, just as a rhetorical device, saying supposing these were kidneys. You can’t trade kidneys.

When I heard that kidney exchange was starting to be done in the United States, I understood that economists knew some things that would help organize the market. Before we started helping organize the market, there were only four kidney exchanges among the 14 transplant centers in New England. At least one of them had been organized by the patient-donor pairs themselves. Two spouses who were waiting for their spouses in dialysis struck up a conversation, what are you doing here, and one of them said, “My husband, but he has blood type B, and I have blood type A, so otherwise I would give him my kidney.” The other one said, “Oh, you know that’s funny, my wife, she has blood type A, and I have blood type B.” They figured out themselves that they could do a transplant and, and they were able to make it happen in New England. Of course, this is no way to organize a market, so what economists brought to the table was the idea of creating a marketplace that we could have a database of patient-donor pairs and use sensible algorithms to try to propose matches that might go through.

Luigi: Can you give us an idea of a sensible algorithm?

Al Roth: You start with a database of patient-donor pairs, and you need a compatibility matrix. You have to have some idea of which patients can take which kidneys, so which donors and patients are compatible. Mostly, the people enrolled in kidney exchange in the United States are incompatible with their intended donor. You have these patients and donors. The donors are healthy enough to give kidneys, but they can’t give it to their intended recipient. You can start guessing, based on the data about proteins that the donor has, the human leukocyte antigens and the antibodies that the patient has, you can start guessing which donations might go through. That allows you to start looking for exchanges, and you can then run the various algorithms. The first one we proposed was top trading cycles. You can look for cycles of exchange that might go through. Now, we wrote a paper on that and we sent it to all the kidney surgeons we could think of. Only one answered, and that was Frank Delmonico in New England. We helped him form the New England Program for Kidney Exchange.

One of the first things they said to us, is they said, “Look, you have this top trading cycle algorithm. It can propose cycles that are big, but because we do surgeries simultaneously, we can’t do big cycles. To just exchange between two pairs, to do everything simultaneously, you needed to do two nephrectomies and two transplants. You need four operating rooms. You need four surgical teams all available at the same time. That’s it. If you want to help us do kidney exchange, you have to help us organize the market on just exchanges between two pairs,” and that’s how we started. When you do that, you go back to old, elegant results and graph theory about matching and undirected graphs, but of course, you lose a lot of potential transplants. When Jevons wrote about barter, what he wrote about, the difficulty of barter, the reason we don’t see much barter exchange is the difficulty in finding the double coincidence of wants.

When you do exchange between two pairs, they each have to have a kidney that the other one wants. Because some patients are highly sensitized, which means they have trouble finding a kidney that they want, it’s hard to find just that double coincidence, but if you could enlarge it to larger cycles, three pairs, say, where pair one gives a kidney to pair two, who gives a kidney to pair three, who gives to pair one, now you enlarge the possibilities and so forth. Eventually, we managed to convince our surgical colleagues that solving the logistics would be worthwhile, and we could do larger cycles. That helped, and then we were already using integer programming algorithms to find, for instance, the maximum number of transplants you could get from a given population of patient-donor pairs. We don’t actually simply maximize the number of transplants because there’s some concern about the quality of the transplants, but you can think about it as maximizing a weighted sum of the number of transplants.

More recently, we get a lot of benefit from chains that don’t have to be done simultaneously, that are started by a non-directed donor. A non-directed donor is someone who is moved to give his kidney and doesn’t have a particular recipient in mind. You can organize a chain started by such a donor by having the donor give to some patient-donor pair, and then the non-directed donor gives to a patient whose donor continues the chain by giving to another patient-donor pair, and so forth. If you do it so that each pair receives a kidney before they have to give one, if a link breaks there isn’t a tragedy where some pair has had a surgery that didn’t help them and no longer has a kidney with which to participate in kidney exchange.

Some chains have been very long. For a time at least, I don’t have the latest data, the average chain in the United States had five transplants in it, so 10 people in the picture, five donors and five recipients. We get really a lot of use out of chains. More than half of the kidney exchanges that go on in the United States now come through chains. Kidney exchange in the United States accounts for 10 percent to 15 percent of the living donor transplants in the United States. On the one hand, that’s a great success. On the other hand, these victories I’m telling you about are victories in a war that we’re losing because there’s a diabetes epidemic. There’s other things going on, so the number of people in need of kidney transplants is growing.

Luigi: What are the major obstacles to setting up bigger and bigger exchanges everywhere?

Al Roth: Well, there are lots of obstacles. I don’t understand them all. Some of them surely have to do with incentives. Dialysis is a very big business, and many of the people who could profit from transplantation are in dialysis. The law requires dialysis centers to inform patients about the possibility of transplantation, but it seems possible that they do so in a way that isn’t effective in encouraging patients to seek out transplantation. I think one of the big obstacles is reaching people who have kidney failure early in the course of their disease and letting them know that transplantation is a possibility.

Another one is letting them know that kidney exchange is a possibility because I think what can often happen is you need a transplant, maybe you don’t know about living-donor transplants, or maybe you do but the people in your family are incompatible, or have kidneys that are compromised themselves. A lot of kidney disease has a genetic component so that someone who has kidney failure, a lot of their relatives might have kidney failure too. I think that if people, early on in their diagnosis, were aware that transplantation, and in particular kidney exchange, were possible, then we’d see more living-donor transplants. Again, Gary Becker used to say, “There’s no shortage of kidneys, there’s a surplus because you have two.”

Kate: Based on your research, what real-world problem do you think needs solving the most?

Al Roth: Well, there are lots of matching markets, markets where you can’t just choose what you want, but also have to be chosen, that aren’t working very well. Of course, the ones that are working worst are not necessarily the most ripe for redesign. Sometimes the reason a market is working badly persists in keeping it working badly, but one matching market that’s working very poorly right now is refugee resettlement that we’re seeing lots of big migrations of people and we’re not good at resettling them, but neither are we good at keeping them where we would like to keep them. It’s a matching market.

You can’t tell refugees to stay at home. Neither can they choose where to go. When you see people putting their children in small boats in the Mediterranean, it’s clear that there’s something wrong with the way that market is working. But of course, it faces all these very serious issues. Lots of people, well lately, there’s been lots of anti-immigrant feeling around the world, not just in Europe, but also in the United States. If we think that there’s going to be large-scale human migration in the future, which there might be in the coming century, for example if the sea levels rise, then we’d better learn from our current failures how to do it better. I would think that that’s something that we should be very actively thinking about.

Kate: Who do you envision on the other side of that match? Is it a host family that’s interested in taking in a refugee family? Is it a municipality that’s interested in piloting a program, or is it a state?

Al Roth: I think that that’s a great question. There’s matching that happens at each moment. The easiest part to tackle, and the part that market-design economists have started to tackle, is how do you place, and house, and take care of refugees who have already been granted asylum in your country. Once refugees are granted asylum, you have to settle them. There was a lot of sentiment among refugee resettlement authorities that refugees should be spread thinly around the country with the hope that that would make them assimilate easier. Of course, when we observe refugee communities, that’s not how they like to be settled. The example I like to give is that there’s a big Somali-American community in Maine. It’s not because of the cross-country skiing that attracted them. It’s that there started to be a Somali community there, and it turns out if you’re a new Somali migrant to the United States, that’s a nice place to go where there are people who can help you out, get started. We have to start thinking of not randomly allocating refugees but thinking what is needed to help them integrate into the host economy.

Then there’s the harder question of who should be granted asylum in which countries. Again, when you see people in little boats, it suggests that we’re not doing a good job, either of the deterring them from coming or of placing them effectively. I say little boats, I’m thinking of Europe and the Mediterranean. In the US, we see unaccompanied children showing up at the border. The system is working very badly. We are not in control of it. That’s something that I would like to see us do a better job of.

Luigi: We have talked about organs. We have talked about immigrants. Can we talk about a lighter application of this, because also the dating market is a matching problem, right?

Al Roth: Absolutely.

Luigi: And generally we don’t use prices for that.

Kate: I have written down, “What do you think about dating apps?”

Al Roth: Right. Well, dating apps are great to talk about because, of course, they’re matching markets and they run into the same sort of generic problems that all marketplaces run into. First, to be a successful dating app, to be a successful marketplace, first you have to make the market thick. You have to get lots of men and women or people who want to date each other on the site. Then you run into congestion problems if you ... Some of the early dating sites, there are so many men and so many women that the internet traffic in which they tried to meet each other starts to be spammy. People with attractive profiles get more emails than they can answer so people who find their emails aren’t being answered send more and more superficial emails to more people, and that gets you a bad equilibrium. A new generation of dating sites came up that tried to curate the email to say that only women could initiate a conversation, for example, or to get rid of conversations entirely and just have people swiping left and right. Those are efforts to deal with congestion.

There’s the whole question of safety and reliability, of should you curate the people on the site so that you aren’t afraid of meeting them. Nevertheless, Americans seem to meet each other, in increasing numbers, through internet dating sites that result in marriages. I think that that has to do with the fact that other matching markets have become less thick. Right? There was a time when few Americans went to college and it made a lot of sense to marry your high school sweetheart because that was the moment in your life when you knew a lot of people of marriageable age, of your age, who were single, and that would be a good time to get married because afterward it might be hard.

Increasing enrollment in colleges meant that wasn’t the last thick market you were going to see. Increasing female participation in the labor force meant that all of a sudden we had people graduating from college and going into work environments where the marriage market might not be so thick. It’s not always so easy to marry the person in the next cubicle. I think part of the growth in internet dating sites is related to the rising age of first marriage and is an effort to keep the market thick, to give people opportunities when they don’t have them day-to-day. I imagine that that’s going to remain a important part of courtship.

Kate: Thank you so much, Al, for joining us.

Al Roth: Well, thanks for having me.

Luigi: Al is a great guy. His contribution is extremely important for economics but more importantly, is also very important for humankind. However, listening to his discussion and listening to how complicated it is to do these matches even with his algorithm and how many people are left out, the question arises: Why don’t we pay for people to donate an organ? Of course, not your heart because it means that you are killing yourself, but what about a kidney? People can very happily live without a kidney. If they’re willing to donate a kidney for money, why is it so wrong?

Kate: Luigi, how much money would you have to be paid to sell your kidney?

Luigi: Wow, that’s a good question because I would give a kidney to my wife and my kids, but I don’t think I would sell it for money.

Kate: All right. Fair enough. I’m not sure there’s a price that I would accept either.

Why was Steve Bannon in Rome last week? Luigi and Kate look at the recent formation of Italy's populist government and analyze Bannon's attempt to forge a similar left-right coalition in the U.S. uniting supporters of Bernie Sanders and Donald Trump.

Fareed Zakaria: So why did I come all the way to Rome to interview Steve Bannon? Well, Italy’s politics were in absolute chaos this week, and Bannon has a lot to say about the subject.

Steve Bannon: We’re coming up on the 10th-year anniversary of the financial crisis. The fuse that was lit then, that eventually brought the Trump revolution, is the same thing that’s happened here in Italy.

Kate: Hi, this is Kate Waldock from Georgetown University.

Luigi: And this is Luigi Zingales at the University of Chicago.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in Capitalism today.

Luigi: And most importantly, what isn’t.

Fareed Zakaria: What a week to be in Italy. I was invited here to Rome by Steve Bannon, who has been an avid supporter of the populist movement here—a movement that has created even more political chaos than Italy usually has.

Kate: Luigi, you were just in Italy this past weekend, right? So are things absolutely wild over there?

Luigi: Yeah. I think things are pretty crazy, but there are a lot of people who are upset. A lot of people that are interested in what’s happening. And I think that what’s happening should be watched also from the United States, because it can be game-changing.

Kate: And I think they were being watched in the United States, right? As of the end of last week, the stock market had tanked, it was down, what, a couple percent? Mostly on news from Italy. There was a lot of volatility due to news from Italy, so I think people are actually paying attention over here.

Luigi: Yeah, but—it’s surprising, said from a financial economist—but I think that the biggest reason to watch Italy is not from a financial point of view, and there are plenty of reasons to watch it from a financial point of view, but from a political point of view.

Believe it or not, Italy is 20 years ahead of the United States. Unfortunately, 20 years ahead down the tube, but it’s 20 years ahead. And I think that you want to watch what’s happening there to understand what might happen here.

Kate: OK, so just to recap really quickly, we did an episode on Italy just about two months ago called “Worse than Brexit,” and on that episode, Luigi shared with us a little bit of insight into what’s going on in Italian politics today.

Luigi: Eventually, a coalition between these two parties, who are anti-establishment, the League and the Five Star, took place after a lot of problems, shenanigans, that I will skip, say for brevity, but I think that the important point is two parties that are kind of like Bernie Sanders and Steve Bannon getting together and form a government.

Kate: That’s insane.

Luigi: And this seems so crazy, in fact, you laugh, Kate, but I think it is not that crazy after all. And that’s what we would like to understand is why they got together, on what basis, and what does this imply for the rest of the world? Because, as we heard in the clip in the beginning of the podcast, Steve Bannon is in Rome, claiming that this is a victory of nationalists against the globalist elite. And is it, and is this the sign that things are changing? I think that’s what we want to discuss today.

Kate: I know you said for the sake of brevity, you don’t want to get too much into the details, but why were markets so spooked as of the end of last week?

Luigi: At some point in the negotiation for forming this coalition, the two parties converged on the name of an economic minister, who has positions that are quite anti-Euro. The president said that he did not want to appoint him as economic minister, because of the impact this will have on the market. This is at the borderline of the constitutional powers of the president. In our constitution, the president is a bit like the queen in England; the president appoints the prime minister and, under the suggestion of the prime minister, appoints the minister. He does have some power in saying no, but generally it is not for ideological reasons. If you appoint a crook as justice minister, I think the president has all the right to say no. If you appoint somebody who’s perfectly qualified to be, but has a different ideology, in principle, you’re not supposed to say no.

But I think the reality is, there was a lot of uncertainty whether one of the two parties in the coalition, particularly the League, wanted to be part of this coalition. My understanding is this tension with the president was used as an excuse to get out and then when they got out, the market was spooked even more. So, they realized that they’d better do something, otherwise the country can fall apart and they are blamed for this lack of government. I think, eventually, sanity prevailed and they did form a government.

Kate: Can you tell us more about how the League is like Trump’s party, and how the Five Star Movement is like Bernie Sanders’ party?

Luigi: I think, for American listeners, the League is relatively easy to explain because, in spite of its historical origin, today it’s very much like a Trump party. In fact, the leader of the League, Salvini, was one of the Western leaders to endorse Trump. They are anti-immigrant. They are very much pro-business, especially pro-small business. They are in favor of cutting taxes; they even proposed a flat personal income tax, which really is not that flat, but at least they claim it is that way. They are really kind of a Trump party, I would say even a Bannon party, because Trump is the combination, in my view, of a populist root and a plutocratic side. I don’t think there is any plutocratic element in the League; it is only the populist side.

Kate: What about the Five Star Movement? How are they like Bernie supporters?

Luigi: The Five Start Movement is, in my view, the most interesting because, first of all, they didn’t exist 10 years ago. And in 10 years, they went from being nobody to express the prime minister. They did that without being supported by any big business, by any big donors, by anybody, and having all the establishment, all the media against them. In a sense, it’s a bit of a miracle. Imagine that you have Jon Stewart hooking up with a Silicon Valley genius—

Kate: Elon Musk.

Luigi: —yeah, maybe Elon Musk, and forming a party together and really going grassroots. Because they start so grassroots and so in a non-ideological way, they are, first of all, not a strong ideological party and trying to express what ordinary people care about. One thing, they are very pro-environment. Which is quite unique in the Italian environment. They are pro-universal basic income. And they are very strongly anti-corruption and anti-establishment. So in that sense, they might resemble a lot to Bernie Sanders’ party. On the other hand, they are, I wouldn’t say anti-immigration in general, but they are worried about the consequences of the way immigration took place in Italy. That is one of the points of connection with the League. They’re not exactly a Bernie Sanders party, but I would say they are pretty close to a Bernie Sanders party also in the way they finance themselves, which is very diffused. Not having strong donors supporting it.

Kate: So now that the League and the Five Star Movement have come together to form this coalition government, what are some of the policies they’re proposing?

Luigi: In a move that is unprecedented in Italian politics, they actually spent almost a month creating a contract between the two parties to discipline what they’re going to do in government. It’s a bit like what Angela Merkel did with the Social Democrats in Germany, and this is fairly usual in other countries. In Italy, it’s unique. However, this document contains mostly how they’re going to spend the money, not how they’re going to raise the money. Which, of course, creates some problems, given that Italy does not have the flexibility of running such large deficits, given the amount of debt it already has. The characterizing element of this is some form of a flat tax, even if the word flat, as I said a second ago, is not precisely right. But some form of fiscal reform that will lower the burden of taxation on individuals and on small corporations.

Second, some form of welfare. Again, it’s not exactly universal basic income because they’re going to make it conditional on searching for a job. But it’s going in a direction of increasing welfare in Italy, which is quite underdeveloped. And then they have a number of initiatives that are much more on the justice side. For example, in Italy, there is this absurdity of having a very short statute of limitations. If you commit a crime, and your lawyer is good enough to drag trial with all the excuses, you end up being acquitted because of the statute of limitations. This law was introduced by Berlusconi many years ago in order to get out of a number of trials. But of course, it not only got Berlusconi off the hook, it got a lot of other people off the hook. In fact, it’s a fairly common idea today in Italy that you can get away committing crimes, especially when it comes to financial crimes, without paying for them.

Last but not least, they want to renegotiate many things in Europe. The most important one is the way immigrants are handled. There is an agreement called the Dublin Agreement that basically gives all the responsibility of accepting and nurturing and supporting the immigrants in the countries that first received them. And then, it makes it difficult for them to relocate those within the European Union. Because most of the immigrants now are coming from Libya, Italy is the country with this enormous amount of immigration, and we don’t have the resources to handle them properly, and the other countries don’t want to accept them. So we are not the country of destination of most of the immigrants, but we are the country that is burdened the most.

Kate: So there seems to be a lot going on in Italy, but I would say that this is hardly new, right? We had Brexit. We had Marine Le Pen in France. We had the populist elections of Orban in Hungary. And then we recently had populist elections in Slovenia. So it seems like Italy is just part of a bigger movement across all of Europe.

Luigi: There is definitely a common element in all these movements. However, what I think makes Italy somewhat unique is it has two populist movements. A more right-wing one and a more left-wing one. What makes it extraordinary is that these two movements decided to form an alliance and, at the moment, they’re running the county. While Trump won an election, first of all, the coalition that led Trump to election is not just a populist coalition, there is a populist part and there is a traditional Republican part. And there is definitely no element of left-wing populism in the Trump administration. This is the first contrast between populists and, if you want, globalists. Even in England, where you had Brexit, the Theresa May government is struggling, but you cannot say that it’s completely an anti-globalist government, while I think that the government that is forming today in Italy is of that type.

Kate: So why is this happening in Italy first?

Luigi: I think this is the result of two factors. One, the very poor economic conditions of Italy. Per capita income is lower than 20 years ago. We had two crises, one after the other, very costly. And we have a very high level of unemployment, especially in the south of Italy. The second is, Italy has 20 years of Berlusconi, more or less, on its back. And 20 years in which the televisions and the main media were somewhat influenced by one description of the world. What happened in the last government, while in principle this government was of the Democratic Party, it had the explicit or implicit support of Berlusconi. So there was kind of an alliance between the elites of left and right that naturally led to a counter-alliance of the people who felt left behind, whether they were ideologically more on the left, or ideologically more on the right.

Kate: Do you see a parallel between Berlusconi in Italy 20 years ago, versus Trump in the United States now?

Luigi: I think I see a parallel between what’s happening and the feeling that people have in the United States today, and the feelings of Italy because it is true that there is a lot of left and right ideology based on civil rights and abortion and religious beliefs, but very little difference in terms of economic discourse. Both the Bush administration and the Clinton administration are very much in the pocket of business. I think that this is exactly what Italians feel about the political environment, that whether it’s left or right, it doesn’t really make a difference because at the end of the day, they play the same strategy, the same policies with a little bit more politically correctness on top, but that’s not what changes the life of somebody who’s unemployed. Whether you are more politically correct doesn’t change his future.

Kate: But I don’t think it’s fair to say, “Oh, there are some cultural differences between the US and Italy, but at the end of the day there’s this unifying theme in economic circumstances.” Because those cultural differences, I think, are huge, whereas the unifying economic circumstances between discontent in the US and discontent in Italy are actually quite big. We didn’t realize two recessions. Our unemployment rate right now is back down to 4 percent. Growth since the financial crisis has been higher than growth in Italy. So we haven’t had it as bad as you had it in Italy.

Luigi: I think you are absolutely right, and that’s the reason why you don’t have such a strong coalition, yet. But imagine things get worse, I think that’s a distinct possibility. Second, I think there is much more variety within the United States than within Italy. There’s a lot of geographical variety in Italy, but I think in terms of growth, it’s true that on average the United States grew. It’s also true that if you look at the median income in the United States, it did not grow for 40 years. So while it’s true that the average income is growing, I’m not so sure that the median American feels that.

Kate: So then you think that this is an epidemic for all of Western societies. That there has been a slowdown in median incomes and, what? You think that this will inevitably lead to the convergence of these populist movements between the right and the left in all Western countries?

Luigi: I think it’s a distinct possibility we need to be worried about because I think that this convergence arises from the convergence of interests on the other side. The fact that, at the end of the day, leaving abortion and gay rights aside, there is not that much of a difference between Bush and Hillary Clinton. So, if they are all too similar, I think that on the other side, people are saying, “Why are we left behind?” The answer is, because of the influence that corporations tend to have, investors in general tend to have on US policies. But also, in the world policies. I think that what is stunning to me, you take the biggest leaders of left-wing movements across the world and they all end up becoming rich catering to large corporations. From Tony Blair, who goes around giving speeches for millions, to Bill Clinton himself, to Schröder, who was the leader of the SPD in Germany, to Matteo Renzi, who is still in parliament, is the former prime minister, goes around giving paid speeches all over the world.

If these are the leaders of the left, I think there is room for a new left. And I understand, this takes a realignment. This does not happen overnight. But let me tell you this funny story: In 2007, I think, Beppe Grillo, who is the founder of the Five Star Movement, wanted to run in the Democratic primary. The guy in the Democratic primary said, “We don’t let you run, go found your own party.” And he did, and now he won the election. That’s a pretty good story, but that is what it takes to realign. I think that if the Democratic Party pushes out everybody with different ideas, maybe there will be another party coming. Another party with some of the characteristics of the left, but not others. What is amazing is, in the world of social media, this is more possible than it was in the past. As the Trump election shows, having all the established media against you is almost like a badge of honor. In the past, it was a kiss of death. Today, it might be worn as a badge of honor and might bring you to the White House.

Kate: I think another key difference between the US and Italy is we don’t have Brussels. We don’t have the EU and the ECB taking the other side against us. There’s no overarching governing body that we feel like is disenfranchising us, whereas I feel like anti-eurozone or anti-Euro sentiment in Italy is what’s bringing a lot of these parties together.

Luigi: Wait a second, you have Washington. The ultimate swamp, right? All the reaction that there is in Europe against Brussels is the typical reaction that people have here against centralized government and against a government in Washington that is competently dominated by vested interests, and not responsive to the needs of the people. I don’t think that there is any difference in that dimension.

Kate: No, but that’s not a fair comparison because Washington would be like ... anger against Washington would be like anger in the Five Star Movement against the establishment within Italy. I see that comparison. But there is also this anger against a broader party of other countries in which Italy feels disenfranchised.

Luigi: I think you are right in the issue that you can play on some ethnic differences in Europe you cannot play in the United States. People in Colorado might feel that Washington is a swamp and that Washington is taking away powers and money from them, but they don’t feel that people in Washington are necessarily different from who they are. And people in Washington don’t make fun of people in Colorado.

What we have seen, especially in recent weeks, we’ve seen the German magazines and newspapers making fun of Italy using the worst stereotypes on the face of earth. Something that probably, in the United States, will disqualify you to speak in Parliament. These were not fringe magazines or newspapers, these were the mainstream media. Even some mainstream politicians. There was one politician that said, “Financial markets will eventually teach Italians how they should vote.” Which is clearly a very anti-democratic thing to say. They don’t even resign when they say these things. Sometimes they apologize, sometimes not. I think that that is really the difference. There is more ethnic fractionalization within Europe than there is within the United States.

Kate: Speaking of fractionalization, this brings me to my last point which I think distinguishes the US from Italy, which is that we have a different history. We have a unique and sad relationship with slavery that still persists and is very dominant in our culture today. We have things like Black Lives Matter and we also have a lot of movements around police brutality towards young black men. I don’t think that that is as strong of an element of the debate in Italy as it is here in the US. I also think that there are other social issues that are much more absent in Europe. For example, gun control. That’s a huge issue in the US. That’s very fundamental to the divide between the left and the right and it’s not at all present in Italy. Even though you might say that gun control is a relatively minor issue compared to economic growth, I think in the minds of most Americans, it’s something that no one is willing to compromise on, and it’s something that will always keep the parties apart.

Luigi: I think you’re right. Of course, every country is different, and the importance of the legacy of slavery in the United States is a tremendous legacy that other countries in Europe don’t have. Even if, now, they do have racial issues because the number of immigrants has increased quite a bit. The issue of gun control is a big dividing issue, so it is possible that the coalition will never form. However, I think that there is an element of truth in the tension between a group of people, let’s call them globalists, that are benefiting tremendously from globalization—and let’s be fair, we are part of that—and a group of people who are left out.

What we need to think is how to fix the problem before this coalition is forming, because I think it would be very divisive.

Kate: I think the solution to how we can prevent a left-right populist coalition in the United States has to stem from a deep and true understanding of what the cause of all this resentment is. There’s some people who claim that these populist movements are coming about as a result of the financial crisis and the inability of Western democracies to heal from the financial crisis. And then there are others who think the roots are much deeper and that they stem from the rise of globalization and technology that started taking place in the ’70s and ’80s. I’m more in the camp of people who think that populism is the result of globalization and technology, and I think that the only solution to these challenges, the challenges that they pose to Western democracies, is to increase the quality of our education so that we’re more competitive.

At the end of the day, though, maybe none of this matters. Maybe Trump is going to implode in a violent Tweetstorm and maybe the coalition between the League and the Five Star Movement in Italy is going to fall apart because ideologically, they’re actually pretty different. So who’s to say that the remedy isn’t going to be that these current governing parties in the US and Italy just fail one day?

Luigi: It’s entirely possible, but I think we should watch this experiment with interest because, if it succeeds, it might change the way we look at politics, also in the United States.

Tristan Harris, a former design ethicist at Google and “the closest thing Silicon Valley has to a conscience,” warns Kate & Luigi about targeted digital advertising that creates individual, orchestrated experiences dictated by nothing more than an algorithm.

Tristan Harris: We live right now in two billion Truman Shows. Two billion individual, personalized, orchestrated experiences where an algorithm is deciding exactly what we personally will see.

Kate: Hi, I’m Kate Waldock from Georgetown University.

Luigi: And I’m Luigi Zingales from the University of Chicago.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Tristan Harris: If I talk about persuasion right now, in this room, we’re probably all thinking, “Well, we’re the smart ones here at University of Chicago. If we talk about persuasion, we’re only talking about those people over there, those manipulatable people. But they’re so gullible.” But actually, persuasion works on everyone. A chimpanzee doesn’t get to choose whether a banana is seductive to its instincts, that’s just how we work.

Kate: All right, so what we’re actually going to talk about on today’s episode is how tech manipulates our brains. We had the opportunity to talk to Tristan Harris, who is known for being the closest thing Silicon Valley has to a conscience. Now he actually started by founding a company called Apture, which was acquired by Google, and he worked as a digital designer for Google for a number of years. Then, he went off to start his own nonprofit called Time Well Spent. He spends a lot of time thinking about, as well as researching, this idea that tech companies have the ability to manipulate our perception.

Luigi: Tristan told us that it was very important for him to start as a magician, at least as a kid he was a magician.

Tristan Harris: It’s super important. Yeah. When I was a kid, seeing the world through the eyes of a magician flips your whole worldview around, because instead of looking at choice as an authoritative thing that human beings are doing, basically you’re looking at reverse engineering and breaking down the entire foundation of this thing that we tend to think of as being in a secure enclave, called a mind. A mind does this secure thing called choice making. Being a magician and having that worldview is all about flipping that completely inside out, using all evolutionary instincts, physiology, attention, psychology, against the spectator or subject, and seeing if you can control, shape choices. Make them believe or see things they don’t see, control attention. It teaches you that those things are highly influenceable.

Luigi: Yeah, but how is that related to your concern about the power of digital platforms today?

Tristan Harris: Well, because essentially what we’ve done is we’ve created a channel by which essentially you have direct access to the human skin of two billion people, meaning you can buzz something in their pocket. You can then use colors, social cues. Basically everything you see on a screen is designed by engineers who people never meet, who basically know a set of persuasive techniques to engage or hook you. That’s the addiction layer.

This problem has two layers. The first is, can we hook two billion people so that they check their phones 150 times a day, from the moment they set their alarm when they go to bed at night, to the moment when they unset their alarm when they wake up in the morning? The answer is yes. That first layer is like, “Can we establish a matrix by which two billion people are jacked in to an environment controlled by two or three companies?” The second problem is that you then create these advertising models where basically anyone has access if they pay the guy at the front door of the control room, aka Facebook or Google, to directly target thoughts and influence to any vulnerable population that they want. I think both these things set up huge externalities and a society that we don’t want to live in, and that’s why we have to change it.

Luigi: You use the term we. What part did you have in that?

Tristan Harris: Well, so I was a tech entrepreneur. I should say that too, in the sense that I know the system from the inside out. I used to have a start-up called Apture. We got acquired by Google. I was friends with a lot of people who made this stuff, so we is ... I went to Stanford. I had a computer science degree. The we is the people in the industry. People don’t often understand how this stuff really works. These are not just products and services we’re trying to build to help serve people. That is a motivation, but the main thing is can you get it to work? Can you get it to grow? Can you get users? Can you get usage out of those users? Can you get them to come back tomorrow? Those incentives mean that we, the people, the engineers, the designers, are really shaping culture. We’re shaping politics. We’re shaping public health, and mental health, and loneliness. These are all externalities of a system like this.

Kate: Was there anything about your time at Google that made you uncomfortable in your work? Did that lead to you leaving and starting Time Well Spent?

Tristan Harris: Yeah. It wasn’t something that Google specifically was doing, just to be really clear. That’s not just to be diplomatic. I mean, I was within Google. They acquired our company. I was a product manager on Gmail. It’s not like Gmail’s goal was to hook people to slot machine-like rewards where you pull to refresh, to see if you got new email, and it was an intentional, deliberate, like, “Let’s turn this thing into Vegas.” But I was uncomfortable that of all rooms in the world where there would be people who cared about email’s impact on the stress, mental health, well-being, anxiety, and distraction of the people that it was influencing, I didn’t get a strong enough sense from that team that we had that responsibility. That email was where information knowledge workers spent a third of their day.

I got concerned about this, and I made a presentation at Google. It was a slide deck. I sent it to 10 people, basically asking for feedback. The slide deck basically said, “Never before in history have 50 engineers in Silicon Valley shaped what two billion people will think and do with their time every day. We have a moral responsibility as Google to get this right, from the perspective of someone who understands how people’s minds work, and cognitive biases.”

This presentation spread throughout Google virally. I got a meeting with Larry Page. It was really more about the industry overall. But I thought Google ... The reason I stayed is Google is one of the few companies that can do something differently. YouTube can’t. It’s stuck in this maximizing watch time model. But Android and Chrome are kind of the gateways between a human being’s brain, and then all these things competing for their attention. So the opportunity was, can we make Android and Chrome better defenders of human agency? I couldn’t unfortunately get much to happen while I was inside of Google.

Kate: I think it’s worth taking a step back and talking a little bit about how companies like Google and Facebook make money. We’re used to the product end of the platform. We’re used to using Gmail or Facebook to post pictures. Or Instagram to post pictures, or to tell our friends about our status. But those aren’t in and of themselves ways that the companies make money. They make money by collecting a ton of information about what we do: from the way that our faces look, to the type of words that we use when we describe our days, to the type of words that we use in our emails.

They aggregate that information, and they try to use it in the best way that they can, to target advertising towards us. The way that they’re actually making money is by charging people who are willing to advertise on their platforms, to be able to target ads to us specifically. If I have, let’s say, if I own a store and the store sells clothing to women, it sells Radiohead band t-shirts, and I want to target my ads to women between the ages of 30 and 45 who live in Pennsylvania, who like to listen to Radiohead, I can go to Google and Facebook and say, “Target my ads specifically to these people.” They have the power to do that.

Not only do they have the power to do that, but they can target it even more specifically to people who have been interested in those types of ads before. Or who when, say, scrolling down their news feeds, have stopped and paused, and looked at ads that are similar to mine before. They have this ability partially just through data, but also partially through machine learning and AI, to target things very specifically.

Luigi: Kate, you’re absolutely right. But I think it would be useful to remind our listeners what is unique about digital platforms, because we keep using this term. But besides the digital, what is important is the platform component. Google and Facebook are what economists call two-sided markets. Two-sided markets, I will explain in a second what they are, are very unique in many characteristics. Let’s start with an example from the 20th century, so even older listeners can appreciate it. Think about the market for classified ads that used to be there in traditional newspapers. You want to buy a house, you want to buy a refrigerator, and you want to go to the place where most people are advertising, or posting their refrigerators or their homes. Vice versa, if you are trying to sell the refrigerator or sell your home, you want to be in the place where most potential buyers are.

You have both the buyers and the sellers trying to go to the same place. The platform is the place where they meet. In the old days it was a newspaper. Today it is Facebook, or to some extent it’s Google. What is unique about digital platforms is you have kind of two clients at the same time. You have the buyers and you have the sellers. You want to have the highest number of buyers so you can attract the sellers, and vice versa. So you’re often trying to subsidize one side in order to attract the others.

In the particular case of Facebook or Google, they subsidize us as consumers, because we get the product for free. But they charge, and sometimes they charge very high prices, to the advertisers. So when we think that we get the product for free, we don’t really get the product for free, for two reasons. One is that we pay a higher cost of goods, because the advertisers are paying a higher price for advertising. Second, we pay with our data. When you quickly sign on to, or agree to the terms of use of Facebook or Google, you are giving away a lot of confidential data that Google and Facebook use to target those ads.

Kate: Yeah, you’re totally right. There are plenty of qualms that you can have with the fact that Facebook and Google do target advertising so specifically. But just in the context of whether or not they actually sell data, I think it’s important to make three distinctions. One is that they definitely target advertising based on the information that they have. Second, I wouldn’t necessarily call that selling data, but you can decide on your own whether or not you think that’s problematic.

The second way that they use data is that some companies or apps interact with the data if you want them to. For example, if I have the Tinder app on my phone, the easiest way for me to connect to Tinder is to let Tinder use all of my information on Facebook. It’s just easier to set up. That way Tinder can quickly import all my friends, and they can know who my network consists of. So it’s easier for me to get people or matches that I think I would like. So I’m OK with that too. I mean, of course there’s a question of whether or not that’s OK. But there is some agency in that, in the sense that I’m allowing my Tinder app to use my Facebook data.

Then finally, there’s this question of companies like Cambridge Analytica, to whom Facebook just handed over some data. The way that it was set up was an opt-out process that no one really knew about. So by signing up for Facebook, you were signing over your rights for Facebook to be able to turn over to Cambridge Analytica whatever they wanted. If you really wanted to prevent that from happening, you would have to figure out how to opt-out, which was pretty complicated.

Luigi: Tell us more about the Persuasion Lab at Stanford. What does it do, and what does it teach?

Tristan Harris: Well, so back to the magician’s metaphor, we tend to think that people cannot be persuaded. If you put on a VR headset, you don’t get to choose whether or not all your millions of years of evolution tell you, “Do not take that step forward, because you’re about to walk off a ledge.” I can know with my mind that there is no ledge in front of me. But if I put on a VR headset and that ledge looks like it’s right there, I’ve got too much evolutionary instincts driving me to say, “I cannot take that step off.”

Persuasion is understanding what are these immutable, deep-rooted features of the human mind and our motivational system. It really was teaching engineers to think about the world in that way. It wasn’t this sort of diabolical manipulators’ lab that was trying to teach you to ruin people, to addict people, or manipulate anyone. In fact, the whole point was, could you use it for good. Could you help people go to the gym if they wanted to go to the gym, or floss, or establish social norms that they wanted? But there was always a danger. In fact, the final class was actually about the ethics, and the future of ethics of persuasive technology.

One group came up with the idea that what if in the future, you had a perfect profile of what would persuade every single mind uniquely. With your mind, are you more motivated by hearing that the New York Times says it’s true, so an authority figure says it’s true? Or are there certain people, out of all the people that you trust that I could tell you that if they think it’s true, then you’re much more likely to believe that it’s true? What if in the future we had this perfect map, that for every single mind, you knew exactly which kinds of things persuaded it? That’s exactly what Cambridge Analytica is 10 years later. Cambridge Analytica is a metaphor for an entire system that basically is also what Facebook intrinsically is. It’s not really about Cambridge Analytica. It’s about systems whose business model is coupled with how best can I service the advertiser, the manipulator, to successfully influence your thoughts.

There’s a huge contradiction built into Facebook. One of two things is true. Either it’s true that it’s a neutral platform, it’s just a tool, users are responsible for their own choices, and they get what they want—in which case, advertising is not effective, and they’re deceiving their advertisers—or it’s true that advertising is really effective, and they’re selling advertisers on that, and it is the best tool in the world to influence and manipulate every audience, which is what their entire business is based on, and I think is also more likely true to the point. But so far these platforms have tried to claim that they’re just these neutral objects. They’re just sitting there waiting to be used. You choose who your friends are. You choose who you like. You choose what comments you make.

That’s kind of like a magician. If I say, “Well at the end of a trick, did you choose whether it was a face card or a number card? Yes you did. Did you choose whether it was a red card or a black card? Yes you did. So you made the choice independently, did you not? I didn’t influence your choice in any way.” You think, you nod your head like, “Yeah, I did make that choice.” But of course, I the magician stacked the deck in my favor many steps ago, and you just didn’t see how that happened.

Luigi: I understand that the power of technology now is much stronger. But the fact that advertisers manipulate customers, or try to persuade them in one way, is not new. I read many years ago in an interesting book that Nestle, for example, introduced in Japan some cookies that had the flavor of coffee, because in Japan coffee is not a taste that they ever experienced. In order to sell coffee in Japan, you need to develop this acquired taste, and so they did it. They put a lot of sugar, because we know that sugar ... and McDonald’s puts sugar in our hamburger because we like sugar more, and so on and so forth.

Tristan Harris: Correct.

Luigi: In what way is this different?

Tristan Harris: This is so important, because this comes up all the time. The number one rebuttal to this whole thing that we’re talking about is, “We’ve always had manipulation. We’ve always had marketing. … I don’t see why we should think about anything new.” There’s a few distinct characteristics. One is the level of intimacy that this persuasion can happen. Just think about access, first of all. We check these devices 24/7, 150 times a day if you’re a millennial. That was never true of any other medium. You drove past a billboard. You happened to see an ad on TV, but not ... I’ve got something up against your skin, causing you to reach for something in your pocket, thinking that it buzzed when it didn’t. I have intimate access to your moment-to-moment thoughts. Even when you’re not looking at a phone, and you go off and do something, you’re still thinking things that were driven by what was in the phone.

Luigi: Actually I read somewhere that 20 percent of the people check their messages even when they are making love, so that’s-

Tristan Harris: Yeah, exactly. We’re addicted to these things, and everybody is. That’s the amazing thing.

Kate: That can’t possibly be true. Oh my God, that’s so sad.

Tristan Harris: It is pretty sad. It is kind of where we are right now. But one thing is this intimacy. The second thing beyond intimacy is social intermediation. Before, I didn’t have direct access to manipulate the way in which you relate to, or all channels by which you communicate with other people. In other words, any time Person A communicates with Person B, we’ve introduced Person C, who can manipulate the terms of that relationship. I don’t mean in certain advertisements, I mean like Snapchat.

I gave this example today, all the time, Snapchat actually uses this technique to manipulate kids called streaks. It shows between two children, the number of days in a row that they’ve sent a message back and forth. They introduce that, so right there in your contacts list you see, here’s my most recent messages. Next to each person’s name is the number of days in a row you’ve sent a message with that kid. Now if that kid is your best friend, you’ve got this going for about 150 days. So what they’re doing is they’re socially manipulating the terms of your relationship. The currency of your friendship is, can I keep this streak going. That is a totally new form of manipulation.

Also, for the advertising. The fact that Facebook knows or would make available to advertisers, the keywords that you are ... they don’t sell this data by the way, but they’ll let you target to it. When you talk to other friends on Facebook, and you talk about anything, that’s open and available now to manipulators. That’s a totally new thing, and the scale is unprecedented. The last thing, the third thing, so first was intimacy, the second was social manipulation ...

Luigi: Can I, just for me to understand, it’s the difference between I’m able to show you a picture, or paint you a room, versus The Truman Show, in which I manipulate your entire life.

Tristan Harris: That’s right, and we actually use that metaphor. We live right now in two billion Truman Shows, two billion individual, personalized, orchestrated experiences, where an algorithm is deciding exactly what we personally will see. We think, if you and I had the same friends, the exact same 200 friends ... So we both have Facebook accounts, and let’s say we have the same 200 friends. You would think that if I open up the news feed on both phones, we would see the exact same set of material, because we have the same set of friends. But that’s not how it works. It specifically ranks whatever it wants to show you. There’s thousands of things it could show you. It selects from that, and orders them based on what you specifically have ... has worked on you in the past, what has engaged you and hooked you. That’s also part of it is a new, unprecedented form of this manipulation is it’s personalized.

The fourth one is that it’s powered by AI, and it’s self-improving. If you think of this as a ... how AI works, the fact that this is actually getting better and better over time to do this through automation, is a huge and new feature of the system.

Luigi: In terms of ... Thank you for this explanation. This is very helpful. In terms of the moral responsibility, I think that other businesses have moral responsibility, too. Going back to food companies, they certainly don’t care too much about our waist, or they don’t care about our health. What you are trying to suggest is that digital companies should have a higher moral ground than the rest.

Tristan Harris: Yeah. I mean, we have a name for this relationship. It’s called a fiduciary relationship, where one party ... if you walk into a lawyer’s office, they know way more about the law than you do, so they can just exploit the hell out of you. And because they have so much asymmetric power over you, and they can exploit you, we don’t just say that they if you do get exploited, “Well that was your fault for going with that lawyer.” It’s like, “No, no, no. This is a party that has asymmetric information, in the same way that a surgeon has asymmetric power over a client, or a psychotherapist does.” But now think about if you stack those up: doctor-patient, attorney-client. How much asymmetric power do they have in those situations? Now let’s put right next to it, side by side, Facebook.

Facebook is like a psychotherapist who knows more about every single secret of your life. They know who you’re clicking on, your old romantic partners that you click on at two in the morning when you feel lonely. They know your every single word choice you use around political topics. You use immigration, you always use the same adjective next to it. They know which button colors light up your brain. They know things about your mind that you don’t know about your mind. Now they have this asymmetric access to information.

The very first step, we should say, “Whoa, that’s a whole new species of asymmetry. We’ve never seen that one before. That’s huge.” Now, you ask: the business model. Who pays that person? In the psychotherapist territory, who has asymmetric power over you, you’re revealing all your secrets to them, you’re paying them, so at least they’re in some relationship with you. So when you add to this huge asymmetry, now the business model for Facebook is actually selling that personal, intimate information about how your mind works, and everything about you. They sell that to a third party. They don’t sell the data, I mean they sell access to manipulate you on that intimate ground, to a third party. That is an unprecedented level, and dangerous level of influence.

We were advising Congress when the November 1st hearings happened on Russia, and that is a huge part of this too. We’re not talking about this just because it’s a fun philosophical debate. It’s very serious geopolitical consequences that are emerging from this asymmetry.

Luigi: What Tristan is saying is that Google and Facebook are maximizing our addiction to those gadgets, and it’s almost like the evil empire is conspiring against us. They’re doing it just to maximize profits, but I’m not so sure that this is something that is right, given that they’re really exploiting our weaknesses, our psychological and biological weaknesses.

Kate: I’m sort of playing the devil’s advocate here, because I see your points, and I agree with your and Tristan’s point to some extent. But I do think that it’s important to point out the difference between something that’s addictive and harmful, versus something that’s just purely addictive. If Facebook knows that I like the color pink, and so they show me a bunch of ads that feature pink more prominently, I mean yeah, they’re trying to get me to click on those ads. But how is that necessarily harming me, just because I like the color pink? Maybe I want to see those ads more. It’s not gonna give me lung cancer.

Luigi: That’s true, but in a sense, this is where the idea that Tristan has of fiduciary responsibility is important, because they do know much more about yourself than you know. So if showing pink is not a problem, if I am somebody that is addicted to alcohol, and they keep showing me advertising of booze, I think that that’s a problem.

Kate: You’ve spoken a lot about Facebook, but ironically one of the people who has really bought into your ideas of ethical persuasion has been Mark Zuckerberg. He’s used a lot of your language to influence the public image of Facebook, as well as the morale of people working at Facebook. How do you feel about that?

Tristan Harris: You’re totally right. Did someone brief you on that beforehand? You must have some asymmetric access to information-

Kate: Perhaps-

Tristan Harris: ... on me that I don’t know about. How do you know this?

Luigi: You don’t know who she’s clicking at night.

Tristan Harris: I know. I know, exactly. Yeah, this Time Well Spent thing isn’t just a phrase. It was a concept that we introduced at this TED Talk in 2014. Basically we were saying back in 2014 that there’s this huge problem with a time-spent-maximizing system. We introduced Time Well Spent. Zuckerberg recently co-opted that phrase, and made it the new design goal for the whole company. It was a surprise to me when I heard that call on November 1st, his earnings call, the same day they were testifying before Congress, saying the new design goal was to make time spent on Facebook time well spent.

It has exactly been used to sort of re-moralize or re-engage the employees, that we have a new goal. We’re fixing the problem. But it really isn’t authentic, because they’re only interested in making sure that your time on Facebook is time well spent, when the whole premise of the work was how to go beyond the advertising-maximizing time-spent model overall. Meaning Facebook can’t be in the business of just enabling you to make choices off the screen: go on hiking trips with your friends, be in nature, take the cooking classes you want, whatever it is that your goals are. They can’t just be in that business, and they could be. Yeah, they have co-opted that phrase, and they have co-opted our concept. They haven’t really given much credit over to us in the process either.

Luigi: They don’t pay a copyright?

Tristan Harris: No. I think honestly this business model is going to come tumbling down. I think that in the future we’ll look back and say, “Why would we have ever given someone who had this amount of power and access, why would we have ever allowed them to have a business model which directly incentivizes them to do things that are not in the interest of the people that they’re serving?” Now the question is, what is a new accountability model that does guarantee that they are ... even with psychotherapists, they can still not be in your interest, even though you’re paying them. So how do we guarantee that trust? In nature and biology, the reason that we can trust a parent who controls the food supply of the child is through genetics. The fact that the child has the genes of the parent means that a parent is intrinsically motivated. Everything in their biology makes them want to be aligned with the party that it’s serving. But we don’t have that in technology.

How could you replicate that? How could you create a system by which something that impacts two billion people treats the agents, not really the agents, the people that it’s serving, with the same level of care and true, genuine, sort of it-can’t-be-any-other-way compassion as we have in biology?

Luigi: Fantastic.

Kate: Tristan, it’s been really great having you.

Tristan Harris: Thank you for having me.

As ad revenue continues to decline more and more news organizations are turning to paid and sponsored content. Luigi and Kate revisit the decades-old music payola scandal and debate how to ensure proper disclosure in the digital age.

Speakers: The sharing of biased and false news has become all too common on social media.

Kate: Hi, this is Kate Waldock at Georgetown University.

Luigi: And this is Luigi Zingales at the University of Chicago.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Kate: A media organization called Sinclair has been in the news recently because it was making its anchors read the same statement, and everyone across a bunch of stations was sounding like zombies just reading the same thing over and over again, which was something like:

Speakers: Unfortunately, some members of the media are using their platforms to push their own personal bias and agenda to control exactly what people think, and this is extremely dangerous to our democracy.

Speaker 4: This is extremely dangerous to our democracy.

Speaker 5: This is extremely dangerous to our democracy.

Kate: To back up for a sec, Sinclair is both a TV and a radio broadcasting company. They own something like 193 just television stations, but there’s also talk about them acquiring even more from Tribune Media soon. What’s ironic is Sinclair was actually fined by the FCC a few months ago in what was basically the largest fine in history because they were found guilty of accepting money in exchange for endorsements.

Speaker 6: More and more patients at Huntsman Cancer Institute are recording their life stories.

Speaker 7: My grandfather’s family all died, usually in their late 20s, early 30s, because they were not diagnosed back then.

Speaker 8: It’s taking too many lives, and my husband at 54, he had a lot to offer the world.

Kate: But they were reporting news tied to cancer organizations as if it were news without disclosing that they had accepted payments for what they were claiming was news.

Luigi: So we’re going to try to unpack today these practices, starting from payola to go to advertising to sponsored content, but we want to start with actually the music industry.

Kate: Yeah, can I talk really quickly about the word payola?

Luigi: Please.

Kate: I just, I hate the word payola. It makes me think of 1950s naming conventions, like Crayola and Victrola. They just added ola. Terms that you may be more familiar with now are pay for play, #sponcon, which stands for sponsored content. But anyway, it’s all the same idea.

Luigi: And this is a practice that has been going on in the music industry since probably the beginning of the music industry. What really shook the industry is that in 1955, four traditional companies were controlling 78 percent of record sales. By 1958, the same four companies dropped to 34 percent, and the reason was the explosion of rock ’n’ roll that was done by other record companies. Many senators got concerned about the spreading of this evil music, and of course, the evil music could only spread because of corrupt practices. As a result, there was an investigation in Congress about the use of payola to promote the new music, which was rock ’n’ roll.

Kate: So anyway, Ronald Coase, who’s a Nobel Prize winner, he wrote this paper describing everything that happened, and his opinion, payola in the music industry was really not that bad of a thing.

Luigi: Yeah, and his argument, I think, is quite clear. Number one, he says it’s not a bribe, because in legal terms, a commercial bribe is when you pay somebody to use his discretionary power in a way in which his boss does not want him to. In this particular case, the radio stations were perfectly happy to have the DJ take that money, and they knew this money was taken, so it’s a little bit like a waiter in a restaurant. You give him or her a big tip to get the corner table. This is not a bribe by any measure of the word.

Kate: Yeah, and another argument that he makes is that from the DJ’s perspective, it doesn’t really make sense to accept money to play bad music, because you still want people listening to your station, and so you’ve got this sort of joint optimization problem, where on one hand, you want to make money by being paid some amounts by these record labels, but you also want to make money through your salary from the music station, which means that you want to have a lot of listeners. So it’s not necessarily the case that bad music was being pushed on a lot of people. Maybe once in a while there was the occasional record that people wouldn’t have normally wanted to listen to that they had to listen to, but for the most part, people were still listening to music that they enjoyed because that was consistent with the incentives of the DJ.

Luigi: Actually, I don’t like that argument too much, because as we will discuss hopefully later, this leads to being too sort of accepting of other practices I have more quarrels with. I’m more intrigued by two points that he makes that are quite clever. The first one, it says, look, it’s not like the rating or the combination of music that you receive on the radio is not distorted without the payola. In a world without the payola, the way that radio supports itself is through commercial ads, and as we know, if you want to maximize audience, you’re trying to play the music that is more enjoyed by people who buy more products, and so you make yourself more valuable to the commercial ads.

So to some extent, the payola was useful in getting the music that actually listeners wanted, independently of the kind of commercial power they had. That’s the reason why they started to play the rock ’n’ roll, because the rock ’n’ roll was appealing to teenagers, but it was not appealing to old farts with a lot of money in their pockets.

Kate: Yeah, so I think Coase’s most compelling argument is that the groups who were really anti-payola were the big band music stations or the music labels of the 1930s, and they were pitted against these new, up-and-coming rock ’n’ roll artists, who they considered obscene. If you think about it, big band was already being played on the radio, and so the marginal dollar spent on payola by someone who was already super popular was not really that valuable, whereas if you were a new rock ’n’ roll artist, then maybe you would want to spend a little bit of money, you want to give a little bit of money to DJs asking them to play your stuff so it would be introduced into the mainstream. So it was really the old incumbents who were trying to fight against the new upcomers and prevent them from breaking onto the scene.

Luigi: And many of the actions to ban payola were actually conceived as a way to restrict this payment and maximize the revenues of the music industry, and that’s the reason why the attacks to payola are very cyclical, because the payola starts as a very common practice, then becomes so widespread that it actually takes the form almost of blackmail, that now the radio controls the access to listeners and they ask for a payment, an extortion, in order to reach the listeners. When this arrives to this point, in a normal situation, you should have an antitrust enforcement. In the payola industry, you have a surge in the protests, and often either the parliament gets involved or people like Eliot Spitzer, who want to run for a political position and think to make themselves popular by going after the payola industry.

Kate: Yeah, so let’s talk about payola or sponcon in the context of today. It shows up all over the place, and I think it’s important that we make the distinction that it can show up in cultural contexts. For example, if you listen to Spotify or Pandora, there’s a lot of concerns that the curators of playlists are being paid off by the artists themselves. That’s very different than if we’re talking about Twitter, which is actually a medium that people use for learning about the news and learning about information.

I think an important component of what makes this so widespread today is the internet. There’s just so many people offering up their opinions and offering up ratings and anonymously posting on Yelp or anonymously blogging, and it’s impossible to tell who’s accepting money and who’s not, and that’s why I think it’s important to make this distinction between news and culture or product reviews.

I think when it comes to culture and product reviews, I have a pretty good sense of when people have been paid for. In news, it’s more difficult to tell, and so I think we should talk about where payola shows up today, but also distinguish between news outlets versus culture and product sales.

Luigi: I think we should distinguish, but honestly, I think it’s problematic even in cultural issues, in the sense that I love wine and I really value the opinion of one wine critic, Robert Parker, who has a publication without ads. I trust him because over time, I really enjoy the kind of wine that he selects, but also, I am reassured by the fact he doesn’t take any ads. In fact, there is an economic paper looking at the comparison of ratings between Wine Advocate and Wine Spectator, and it finds that the difference in ratings are correlated with the amount of advertising that Wine Spectator gets. So there is this at least prima facie evidence that even traditional advertising might distort content in a major way.

Kate: OK, well maybe you like wine, but I like makeup, and I follow an Instagram makeup artist named Militza Yovanka, and she obviously accepts money from makeup producers. I think that she’s probably getting a lot of money from L’Oreal, I don’t know, different places. She posts these videos where she’s doing her own makeup using all these different products, and I know that she’s being sponsored by these products, but it doesn’t really bother me because A, she’s really good at doing her makeup, and B, I feel like I can tell the difference between when she’s doing something promotional and when she’s not, even if it’s not disclosed.

Luigi: I would like to test you on that declaration. You’re definitely right that you like wine more than I like makeup, so I think that you have clearly a lot of absolute and comparative advantages there. But I don’t claim I can tell the difference. And I have no problem if you announce that you’re just showing stuff that you have been paid to show. That’s part of what advertising’s about. I’m more concerned when you cannot tell the difference, and honestly, if it comes to wine or makeup, it’s not the end of the world. When it comes to news or important information that makes you decide, for example, on your lifetime savings, that’s quite important.

Kate: So when it comes to payola in culture, where do you fall?

Luigi: To me, the crucial aspect is deception, or the risk of deception, and in the case of payola, actually Coase has a great argument, and in my view, I’d say, “Look, music is an acquired taste, but you need to listen to it to know what it is, and while it’s true that the DJ is forcing me to listen the first time, actually I don’t buy the music unless I’ve listened to it. So it’s not like I’m deceived because I don’t know what I’m buying. I know exactly what I’m buying, and the only thing that the DJ is doing is exposing me to that music.” I don’t particularly like, for the wine, even if for most wine, the worst that can happen, you buy a bottle and unless this is a Château Lafite 1955, it’s not a fortune, and then if you don’t like the bottle, you can make up your mind and discard it.

I think that the argument is quite different if we move from the music industry to other systems of exposure, where the good is not that easy to identify. Suppose I am a travel editor of a major magazine, and I receive payment to promote particular locations. As a buyer, you don’t know if the reason why I rate this trip in Myanmar as the most valuable trip of my life is because it’s really great or because I got paid, and you’re only going to find out after you travel to Myanmar. So it’s very different from music.

In many other situations, it’s very difficult to not be deceived. If you trust somebody to give you an opinion, you would like this opinion to be unbiased. The more the good is an experience good, the more the good is a good that costs a lot of money, the more the risk of deception, the more I am against this practice.

Kate: Well, exactly. If it’s a really expensive product that you’re about to buy, then I think I would be willing to pay for a unbiased report, but if it’s just various shades of lipstick, I think that it’s not worth it for me to pay for an unbiased report. Instead, there’s so much competition in the blogging and Instagram space for these sort of relatively cheap products that if I get fooled by somebody, then I’m going to stop watching their Instagram channel and I’ll just go to somebody else, and so I think that there are incentives for people to report somewhat accurately.

Luigi: OK, so let’s agree that for lipstick and music, we don’t care, but then when it comes to portfolio investment or pension retirement plans or stuff like that, this is even more important than your restaurant or your car. If you are a reputable journal or magazine and you can rely on a very diversified set of advertisers, then you are not dependent on any one of them. Once the set of advertisers shrinks, because if you are a money magazine, there are only so many advertisers you can deal with, and annoying one of them can be very expensive. And actually, the most extreme form of this, a colleague of mine experienced a tragedy: her son was killed, 20 years ago, by a defective crib in the kindergarten where he was.

Kate: That’s terrible.

Luigi: Yeah, it’s terrible, and this person is a very lovely person who tried to transform this tragedy into a good for humankind, so she made a battle to try to expose defective products all over the place. The first place where she went to place the news of this tragedy and a warning for the defective crib were parenting magazines, and to her surprise, the New York Times and the major newspapers were willing to publish the news, but the place where she found the strongest resistance were parenting magazines, and why? Because if you are a parenting magazine, you rely very heavily on a few advertisers, and one of those was actually the producer of the defective crib. And if you have only a few advertisers, you cannot afford to piss off any of them because you end up losing, let’s say, 20, 30 percent of your ad revenue, and that is something that a magazine cannot afford to do.

The reason why this story, besides the tragic aspect, but the reason why this story is so important is because I fear that even the mainstream media is going that direction. There used to be a time in which advertising was plenty, and so magazines and newspapers were very independent because they could annoy any one of them and still have a queue of people who wanted to advertise in the magazine. I think that time has gone with the internet and the diffusion of Facebook and Google and different types of digital ads; mainstream media cannot be this picky anymore, and they are heavily dependent on a few large advertising budgets, and that ends up distorting the news they report.

Kate: I think that’s a really interesting point that you raise about the concentration of your advertisers, I think that it ... I agree it probably has something to do with the way that advertising has changed and the pressure coming from competition from Facebook and Google, but if anything, those are reasons that we need to be supporting our independent media organizations, and so I’m just sort of, I’m at a loss for what to think about that, because on one hand, this heightened competition is leading to adverse outcomes and reduced reliability of the news that we consume, but on the other hand, I want to be supporting our news.

Luigi: Yeah, but the way to support the news is not by hiding a problem that’s been going on for decades, now it’s become worse, but has been going on for decades. Because while it’s true that it was easier to annoy one single advertiser, it’s also true that when there was an entire industry and this industry was important, then even the traditional media in a traditional time did not do that great. There is a study showing that magazines that did not receive any advertising from cigarette companies, at the time where advertising was possible, were 40 percent more likely to report news about the health consequences of smoking than a magazine that did take advertising, and similar stuff has been true about research on passive smoking. I think that the acceptance of tobacco advertising has been correlated to less articles and articles more critical of the research on the damage of passive smoking. So I think that this problem has been going on for a long time.

Now, you might argue that this is simple correlation. It doesn’t prove that they pulled out the articles because they were writing negatively about the industry. It might be that if I am a cigarette manufacturer, I want to advertise naturally in a magazine that has as customers people who like smoking or are more open to smoking, and that’s a natural coincidence. However, even if this is pure correlation, it does have a very strong implication. If I want to maximize my ad revenues, I better not talk negatively about smoking when smoking could advertise, and the same is true for a lot of other products today.

Kate: Yeah, I also think that’s an important point. One of the defenses of payola that was raised earlier, which is that people are used to seeing advertising all the time and so they’ve naturally built up these defenses and ways to recognize advertising, that still doesn’t address the fact that there’s information that’s not being reported, and so on one hand, a promotion may be something that people can defend against, but people can’t figure out bad things about companies if journalists are not willing to uncover those bad things because they’ve been supported in other ways by companies.

Luigi: And actually, what is positive is our academic journals that we normally publish in and read in economics and finance tend not to take ads in any major way, and so at least this distortion is not present, but when you go to medical journals, medical journals do take ads, and most of the ads are from pharmaceutical companies, and there is literature documenting some concern by the editors about the influence of the ad companies or the companies that produce the ads, mostly pharmaceutical companies, on actually the articles that get published in scientific journals. So this is even worse than the bias in the normal newspapers, because this is the academic community that should decide what is good for us in terms of what medicine we should take when we’re sick being distorted, and the major episode, hopefully it’s isolated, but there’s a major episode of the executive editor of the transplantation and dialysis journal that rejected a paper in spite of a favorable peer review, and he said, and I quote verbatim, that “The author went beyond what our marketing department was willing to accommodate.”

Kate: So Luigi, you’ve written a ton in many different news outlets about your opinions about the economy, about politics. Has anyone ever approached you and asked you to accept money?

Luigi: Yes, actually. It was many years ago. It was during actually the Parmalat bankruptcy. You’re an expert in bankruptcy, so you might enjoy that.

Kate: Actually, Parmalat means a lot to me, because my first job having anything to do with finance was looking into the Parmalat bankruptcy, but yeah, go on.

Luigi: So at the time, the international creditors were afraid to be taken for a ride by the Italian judicial system, probably not completely without reason, and so I got a US lawyer who came to my office, and when a lawyer actually comes to your office, you know there is something pretty important, because their time is very valuable and they generally don’t come to your office, they ask you to go their office. So he came to my office actually with a colleague, so two lawyers in my office, and they were trying to convince me to write a piece defending the interests of international creditors, and I said, “Look, you might be right, but because you offered money for this, I’m not prepared to do anything.”

Actually later, I discovered this is more diffuse than you think. For example, after the Iraq war, Qaddafi, then a dictator in Libya, was trying to show himself to the West as a reformed guy, and hired a consulting firm in America. This firm hired a lot of famous academics. One was actually a former dean of the London School of Economics. And these academics started to write articles all over the world where they were celebrating how great the changes in Qaddafi’s regime were, and nowhere to be seen was any disclosure that they’d taken money for that.

Kate: Yikes.

Luigi: If it wasn’t for the fact that eventually Qaddafi was killed and this stuff was exposed, we would never have known about this.

Kate: So the FTC explicitly has rules against unfair or deceptive business practices, and we may think that, “All right, it’s a government organization, it’s slow moving, it’s not up with the times,” but actually just recently, they sent out 90 letters of censure to what they called influencers on Instagram and YouTube, saying, “You’re not disclosing your endorsements or your sponsorship. You need to be doing this,” and they even followed up with 21 of them who didn’t listen to the FTC. So these investigations are going on. I don’t think that the FTC has been harsh enough in enforcing actions against people who may have accepted payment for endorsements, but I imagine ... I mean, these rules have existed for a long time and they’ve applied to journalists, as well.

On top of that, there are plenty of organic rules within journalism that maintain codes of ethics or maintain the quality of the journalism that’s produced. Like for the first time, I published a few weeks ago something on The Hill, and I had to sign a contract to be an independent contributor with The Hill, and very clearly in a couple paragraphs of that contract, it said that you cannot have accepted any money for this, “We have the right to state in your article that you have accepted money in order for sponsorship, or we have the right to just not publish anything altogether if you’ve accepted money,” and I would’ve had to disclose that. I mean, I didn’t, but it was there in the contract, and also, if you’re working for a reputable news organization, then your ass is going to be fired if your bosses find out that you’ve accepted money from anybody, and I think that they maintain, at least at the highest levels, very strict codes of conduct.

Luigi: It’s true, but those codes of conduct were not able to prevent, for example, those articles I mentioned about Qaddafi. So I’m not so sure that they’re so effective, and now, some mainstream media accept endorsed or sponsored content written by actual journalists of that newspaper. If you on one article write sponsored content paid by somebody, how can you be independent on the other articles you write?

Honestly, the newspapers made a mistake in the early 2000s thinking that they will make money with online ads and that the only game in town was to conquer eyeballs and you will be done. What they didn’t understand is that there were two or at least three major trends that killed them. Number one is the supply of ads increased tremendously. The media industry used to be a fairly oligopolistic industry with ability of some market power. With the internet, you can reach customers in so many ways that you lost on market power.

Number two, that Facebook and Google can do targeted ads so much better than the traditional newspaper that it’s not even funny. So at the same time, the demand went down and the supply went up and prices of traditional ads went to the bottom, and this destroyed the traditional media industry.

And the last coup de grace, the last sort of killing aspect, was the fact that the media industry was living a lot out of classified ads, and Craigslist killed that goose with the golden eggs, and so now the media industry is competing on very thin margins, and the only way to resurrect it is to have people realize that content is valuable and you have to pay for it.

Kate: Yeah, there was an interesting survey conducted by some polling firm called Toluna. They asked people whether they agreed that there should be no charges to access news websites online, and 96 percent of people think that news online should be free, which is pretty shocking.

Luigi: But the point is, what is the quality of what you’re getting? I think that what we need to do is to educate people, and I think it’s a lesson that we all have to learn, which is if you don’t pay for something, it means you are the product. You are the one being sold, and there is an agenda underlying, and that’s a problem. And I think that we should all make an effort in paying for news, because if you don’t pay for news, you get what you pay for.

Kate: I agree with that, and I have noticed this trend in more paywalls, which can be a little annoying, but I think like five years ago, every article that I looked up, I could find some way to get it for free. Whereas today, that seems to be less and less the case, and I think it’s because it took awhile for major news organizations to get used to shifts in technology, and it wasn’t really obvious right away what the best way to preserve their integrity would be, and I think what’s arising is that these subscription models have become the way for news organizations to maintain their independence as well as the quality of their journalism. It’s really easy for people to be considered sources of news even if they aren’t actually, which makes it that much harder for actual news organizations to compete.

Like Snapchat is now under the FTC’s guidelines. Podcasts are not. Podcasts are still sort of a gray area, and as a result of that, if you listen to other podcasts ... So we haven’t accepted any advertising yet. That’s not to say that we won’t necessarily in the future, but other podcasts that do advertise, you’ll notice that when you hear an advertisement, oftentimes they’re read by the host him or herself. Right? They’ll just be like, “I use Harry’s razors and because I love it so much for my small business and my armpits,” or whatever, and it doesn’t need to be disclosed. So I think that it’s important for the government to pick up on this and to pull in podcasts, as well, under their supervision.

Luigi: Full disclosure, I’m not being paid by Wine Advocate. I wish I were. No, I’m just joking, and by the way, Kate is not paid by the famous makeup artist.

Kate: Yeah. I promise.

In the brave new world of cryptocurrency the latest frenzy involves Initial Coin Offerings (ICOs), which make Bitcoin look tame by comparison. Luigi and Kate explore this volatile, largely unregulated market and consider creating their own ICO.

Speaker 1: Bitcoin crossing the $14,000 mark.

Speaker 2: Cryptocurrency passing $15,000 for the first time ever.

Speaker 3: Now it looks like we may hit the $17,000 mark.

Kate: Hi, I’m Kate Waldock from Georgetown University.

Luigi: And this is Luigi Zingales at the University of Chicago.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Speaker 6: If you think the DOW had a bad day, Bitcoin’s was worse. The price is now hovering around $7,000.

Speaker 7: What do you think of the volatility of Bitcoin and the chance that it could lose all serious value?

Speaker 8: How do you regulate the cryptocurrency market?

Speaker 9: It’s a fair question.

Speaker 10: In terms of cryptocurrencies, generally, I can say almost with certainty that they will come to a bad ending.

Luigi: Everybody’s talking about Bitcoin these days, but a phenomenon which is related to Bitcoin but is actually broader and quite important is this new phenomenon called initial coin offerings. What we’re going to try to do today is try to understand what is this phenomenon and to what extent this is a fraud, to what extent it is for real, and what you should be aware of.

Kate: You’ve probably heard about Bitcoin, and maybe you’ve also heard about Ethereum or Ripple, even. But there are certain types of cryptocurrencies called tokens that you probably haven’t heard of.

Luigi: My favorite one is Bananacoin. A token whose value is linked to the price of a kilo of bananas. This is actually a ICO, initial coin offering, that took place last month and raised a significant amount of money to actually finance an investment in a plantation of bananas in Laos to export bananas into China.

Kate: My favorites are a little more salacious. I’m not sure, but maybe you’ve heard of Groincoin or Tittycoin or Lust. There’s a whole bunch of them out there.

Luigi: Sorry, I sound like a dork, but what are all those coins?

Kate: As you can imagine, they are linked to online porn.

Luigi: I think it’s important that our listeners understand that ultimately what money is is simply a trusted ledger. I know that most people have in mind money as gold because historically, that was the way the trust in the ledger was created. But even today with the US dollar, there is no relation between the US dollar and gold or silver or any other valuable metal. The ultimate ledger is kept by the central bank, which is the Federal Reserve Bank.

To make this point, I think in a very clear way, I want to tell a story that is described by Milton Friedman in a paper in the early ’90s. He talks about a group living in Micronesia, the Yapese, living on the island of Yap. One characteristic of this group is that in order to transact among themselves, since they didn’t have any precious metal on the island, they used pieces of stone, gigantic pieces of stone that could not be actually transferred from one guy to the other, but could be reallocated in property from one side to the next. If I want to buy some milk from Kate, I simply reallocate one stone or piece of that stone to Kate in exchange for milk. Kate and I agree that that’s a transaction, and we write on the piece of stone this transaction, and everybody on this small island knows each other and they trust that this is the actual transaction.

The irony that makes this point very clear is that they were trying to mine for this stone on a far away island, and as they were bringing back one of these gigantic pieces of stone, the stone ended up falling at the bottom of the ocean. But everybody in the Yapese community knew that this stone existed at the bottom of the ocean. They used this piece of stone that nobody could see as a means of exchange without even seeing the piece of stone. This makes it very clear that what money is doing is simply keeping track of transactions in a way that everybody trusts.

Now in a small community like the Yapese community, the trust is given by the social network of social pressure. Once you start to have exchange at a distance, you either give a bond in this transaction, and that bond is the value of the metal associated, or you have a superior authority that maintains this record in a trustworthy way. That’s what the dollar is about. Or, and this is the innovation, you have a currency that keeps track of all the transactions without a central authority in a way that it cannot be modified by anybody—that’s what Bitcoin is about, it’s a currency based on the decentralized ledger that is not mutable because of a combination of cryptography and the distribution component of this ledger.

Kate: The history of Bitcoin, every single transaction that’s ever taken place, sits on everyone’s computer who’s mining Bitcoin. Everyone has the same exact copy of this ledger that accounts for all transactions. If you want to change a particular transaction, if I want to say, “Oh, I paid Luigi 10 bitcoin,” and then take that 10 bitcoin back and give it to myself again, I would have to find the block that contained that transaction and alter it. But if I alter the transaction in the ledger, that then changes the link to all of the other blocks in the chain. That makes it really hard for people to go in and hack or alter the ledger.

Why do I use dollars? I mean, yeah, sometimes I have actual, physical dollars and I use them to buy stuff. But for the most part now, I use my debit card or a credit card to purchase stuff. I trust that Bank of America, when I buy something, it’s going to keep track of the transaction that I’ve made. And then it’s going to deduct the amount of what I bought from my bank account and it’ll give it to whoever I purchased that thing from. Likewise, if money is transferred into my account, I trust that Bank of America is keeping track of that money and that Bank of America isn’t going to be hacked—or American Express or whatever credit card you use. I trust that they’re not going to be hacked to the point where they no longer have any track of who’s purchasing what. That’s the idea and the importance of a secure ledger.

By the way, there’s a TV show, a socialist dystopia TV show, called Mr. Robot, which I highly recommend. The whole premise of the show is that they hack credit card companies and therefore destroy all credit because people can’t keep track of who owes who.

Luigi: Yes, but given that something is not hackable and so potentially could be a currency doesn’t necessarily mean it will be a currency because what determines the success of a currency in part is driven by how many people are willing to use it. The irony of the Bitcoin in this moment is that people who invest in Bitcoin, invest in Bitcoin in the expectation that this will become a standard currency for exchange. However, the more they demand this currency for speculatory reasons, the higher is the value of this currency and the more it will appreciate. And the more it will appreciate the less people are tempted to use the Bitcoin for transactions because whether I want to buy a pizza or sell a pizza, if the price of the bitcoins in dollars fluctuates wildly, I don’t want to use that for transaction purposes. In fact, at the last Bitcoin conference, they did not accept Bitcoin as payment. They did not accept it as payment because it was very volatile.

Kate: We’ve talked a little bit about what cryptocurrency is and what currency is in general. But we started this episode by saying that we want to talk about tokens and initial coin offerings. What distinguishes a token from a cryptocurrency? I like to think of this example of going into a video game arcade. You take your dollars and you purchase the currency of that particular arcade. These days it’s like a card that has some tokens on it and you use those tokens to play games. One game may be three tokens and the really good games may be six tokens. That’s kind of the same idea behind the coins that are being issued in these ICOs. They are a virtual means of exchange that are linked to a particular company. This idea of a token has become super popular.

Luigi: I don’t have a lot of experience on video game arcades, but when I was a kid in Italy, in order to make a phone call you had to use a token. Let’s say that the token was worth 25 cents. Instead of using a quarter, you would use the token. Now, because that token was so widespread, people will take it in exchange for a quarter because the telephone company was selling tokens for a quarter, was accepting tokens for a quarter, so it was basically providing a liquidity for having a token worth a quarter. People started to accept the token as money. The difference between the two is not that big as you make it to be.

Kate: I’m not saying that there couldn’t exist some bizarre state of the world where tokens are so popular that they actually end up being used as currency themselves. But I don’t think that it was the initial purpose of the phone company or the telecom utilities in Italy that these tokens were then going to replace currency. It was just that they happened to be that popular.

Luigi: I agree. That was not the intention of the telephone company in Italy. But I think it is the intention of many of these cryptocurrencies to become a substitute for money. When you look at Ethereum, Ethereum is a cryptocurrency like Bitcoin and was created to enable a set of transactions. We use it as currency within the universe of Ethereum, but ideally they want this universe to be the entire universe.

Kate: Yeah. This is, I think, a little bit of a confusing point. But you’re absolutely right. But it doesn’t need to be a currency company that ICOs. For example, you could have Bananacoin that’s intended to be used for purchasing and supplying bananas. I don’t think whoever ICO’d Bananacoin was intending for Bananacoin to become like the world’s premier virtual currency. They intended it to be used within a certain, more limited context. The point that I’m trying to make is, yes, even though cryptocurrency companies can ICO, non-cryptocurrency companies like any regular company can try and raise money through an ICO, and that’s what becomes dangerous.

Luigi: Disney could raise money by selling Disney Dollars. Those are tokens accepted in Disneyland and they could raise money this way. Now, they don’t need to raise money. But if they needed, they could. However, I think that part of the confusion is exactly this is the reason why so many companies now are raising funds this way is because people are very excited about the increasing value of Bitcoin and they want to jump on the new Bitcoin wagon. They are buying Bananacoin because, I don’t think they’re speculating on the price of bananas, they are hoping that this coin will become more accepted and will be more valuable. That’s, in my view, the reason why so many people buy these tokens from unknown companies with unknown track records and with very vague projects.

Kate: What blows my mind is that these tokens are actually really easy to create. Luigi, if we were to start a company what would it be?

Luigi: It would be the Capitalisn’tcoin.

Kate: OK. This is our podcast coin, and you need these coins to be able to listen to our podcast. If I wanted to actually issue some of these coins to raise money to, let’s say, invest more in our podcast, I could do that relatively easily. Let’s say I’m going to start with Ethereum, which is another popular cryptocurrency. I’m going to link it to that. First I need some Ethereum. I need an Ethereum account and I need a virtual wallet that has my Ethereum in it. And then I need to be able to code just a tiny bit. I just need to be able to edit some code.

What I do is I go online, I download what’s called a smart contract, which was written by this person named Bokky Poobah. I edit a couple lines of the code that say, “All right, this is owned by Luigi and Kate. It’s called Luigi-and-Katecoin. This is the amount that I want issued.” I just hit enter. And then within a few minutes, we would have our own tokens that would potentially be linked to our podcast. And then all we would need to do is create a website, write up a 12-page paper that says this is what we’re going to use these coins for, and then give it to some exchange, some other website that’s selling these coins off to the public, and we would probably raise millions of dollars doing that. That’s exactly what these companies are.

Luigi: But the crucial part to understand is why people are willing to pay millions. Certainly if we produce a piece of paper with, let’s say, Katedollar—I think that sounds better than Luigidollar, Katedollar, a big picture of you in the middle—I’m not so sure people are buying that for a huge amount of value. But in many situations they do. Why? Because the companies promise to use those tokens in the future for some valuable purpose. For example, I have a student who actually is in the process of doing an ICO as we speak who invented a new way to store your cryptocurrency in a digital wallet that is very secure, and is trying to finance the production of this through some tokens. He promises that people can use these tokens to buy this crypto wallet or to pay for transactions in the exchange he will establish.

That’s what is interesting with ICOs because it’s in between some kind of crowdfunding. We know that people have raised money in crowdfunding by promising to give at a discounted price, or at zero, a product to the people who contribute to their endeavor. Here, instead of promising necessarily the product, you give immediately some tokens that can be used to buy the good or can be used for something else.

Kate: I’m sure there’s some completely legitimate businesses out there that have good business ideas and a team put together to actually use the money that they’ve raised to create good products. But what’s concerning about ICOs right now is just that a lot of investors think that this is an easy way to make a quick buck. They’re so interested in trying to double their money or make 1000 percent ROI right away that they’re not really doing much research into what these startups are.

For example, there is a token called UE Token. You can look at it at When you go to the webpage, it says immediately, “You’re going to give some random person on the internet money. And they’re going to take it and go buy stuff, probably electronics to be honest, maybe even a big screen television. Seriously, don’t buy these tokens.” They raised $40,000. I mean, yeah, $40,000 isn’t a whole lot. But there are still people who are not paying attention to the extent that they didn’t even read it. They just gave that person money. Hey, I would like $40,000 if I could. That was like a hack. That was obviously not real. But there are a lot of people across the world, like in Russia for example, who are trying to make websites and descriptions of companies that look very real that are raising hundreds of thousands, if not millions, of dollars from American investors through these tokens which will never be put to good use.

Luigi: If you’re saying that there is a speculative frenzy and things are out of whack, I completely agree. But this is not limited to the ICOs. We are of the view that we’re not there to regulate stupidity. To some extent, people can take a gamble as long as they are aware that they are taking a gamble.

Kate: Whoa, whoa. The US government is absolutely in the business of regulating stupidity. That’s why we don’t have casinos everywhere. And that’s why most forms of online gambling are illegal. That’s why even sports betting is probably going to be highly regulated soon. That’s why the Consumer Financial Protection Bureau exists. The government doesn’t want people who have worked really hard to earn $15 an hour and put away $3,000 in savings, the government doesn’t want that person to try and go triple their money by investing in cryptocurrencies in the same way they don’t want them betting on a horse. I think that the risks in cryptocurrencies, particularly in ICOs, are a lot worse. There’s a lot more potential for just outright fraud.

Luigi: I agree. But I don’t agree with the strong position that, for example, China or South Korea took to say every ICO is illegal. Some ICOs can be legitimate. We want, with the proper amount of protection, but we want people to experiment. I think that in some situations, the ICO could be a very effective way to raise money. Why do we allow crowdfunding of products by financing the purchase of future products and we don’t want to allow ICOs?

Kate: Here I think it’s important to talk about what exactly the SEC did. A few months ago the SEC took the position that they’re going to start regulating ICOs and tokens that are created by them. And the way they’re going to start regulating is that they’re going to distinguish between tokens that are utility tokens versus tokens that are security tokens. A utility token might be something like, OK, Luigi and I want to raise money for our podcast. We create a token. We issue it to people who want to purchase them. And if you buy a token then you can listen to one of our special podcasts because that token is linked specifically to a good that you’re going to get in the future.

But some startups are also creating tokens that are linked to, say, cash flows of the start up. A company might say, “Oh, we’re going to raise tokens. And if we make money in the future, you’re going to get like one tenth of one percent of the cash that we make each year.” That looks an awful lot like just a regular stock that people could purchase except the way that the stock was issued was behind the back of the government. Most companies when they issue stock, they have to comply with a bunch of regulations. And issuing security tokens is a way of doing this without government oversight. The SEC is saying you can issue these utility tokens, but you can’t issue security tokens.

Luigi: The problem is that this is a world market. The United States can prohibit the ICO. You can do the ICO in other countries. My student has organized the ICO in Singapore. We know that you can pay with bitcoins for an ICO, bypassing the banking sector. You’re an American investor. You can buy an ICO with bitcoins in Singapore. There’s very little you can do in the United States unless you ban Bitcoin and you put in jail everybody that even touches one.

Kate: You think that we shouldn’t try and regulate anything on the internet?

Luigi: No. But I think that there are some things that are easier to regulate than others. I think that the problem we have here is the fact that the internet is creating a world market for securities. Up to now the market for securities has been quite segmented. It’s been segmented by regulation. It’s also being segmented by the difficulties in subscribing across the border without using the traditional banking network. And the traditional banking network is supervised by the US authorities because this network works in dollars.

Now, with Bitcoin, this banking network can be bypassed. And that opens really a new world in terms of regulation because the power of the United States is dramatically reduced as a result of that. The power of the United States to nudge regulation all over the world has been reduced. And now we are in a world of more competitive regulation that will probably tend to go to the so-called race to the bottom because competition will lead to regulation to be lower and lower everywhere.

Kate: If anything, I think that regulation of ICOs right now is leading a race to the top. A lot of countries are trying to protect their citizens by enacting really strict regulations on ICOs. I think that the US should be part of that. I think that our citizens are only going to keep being hurt until we do that. But I also think that there is a point to be made about protecting people’s faith in well-established capital markets particularly in the US. The SEC regulates securities that are being issued by companies, and as you pointed out one of the problems with ICOs is that start-ups can make tokens that don’t really look like securities even though they may be securities. That will lead to an explosion of companies raising money through these ICOs and dodging the regulation of the SEC. That’ll be cheaper. It’s cheaper for companies to issue not under regulation than it is to issue securities while being regulated.

Right now we have faith that if you invest in a stock, you’re not going to be ripped off. There’s a sound system of corporate governance. And there is no guarantee with these start-ups that are issuing tokens through ICOs.

Luigi: I agree with most of what you said. I am, however, worried about throwing away the baby with the bathwater. Is there a lot of bathwater in ICOs? Absolutely. Is it all to be thrown away? No. It is an innovative way to raise money. I think it is possible—of course there will be litigation, but there is litigation in everything in the United States—it is possible to try to mark some boundaries of what is a security and what is not a security. And I envision that this method could be useful to launch new platforms, in the sense that we know that in a world of winner-take-all markets the rents tend to accrue to the creator of the platform and to some extent in a disproportionate way.

Let me make a concrete example. Suppose that now I want to compete against Uber or Lyft in the market for basically passenger services. The way I want to compete is by asking a lower percentage fee from the drivers and offering the same price to customers. Now, the drivers will come to me, but the customers will not see a lot of the benefits of coming to me, so without customers there will be no drivers and my platform will disappear. However, if I can incentivize customers to start using this platform by giving them some tokens and saying, “If my new platform will be very successful, these tokens are redeemable in free rides at some point,” then I have a very easy way to market it. That facilitates entry, facilitates competition, keeps lower the prices of Uber and Lyft. I think that overall it’s a great thing.

Kate: I acknowledge that tokens and ICOs represent an innovative way of raising money. But we don’t need some new-fangled cryptocurrency. We already have crowdfunding platforms that allow companies to easily raise money for a future product. Yeah, we would be putting a bit of a damper on companies that are legitimate that are raising money this way. I just think that the benefits of regulating it out of existence outweigh the costs. Also, by the way, I want to make an important distinction here. I think Bitcoin and blockchain technology is incredibly important. I think once the volatility that is in large part driven by ICOs dies down that it will be continually used as a medium for exchange. And I also think that blockchain technology and cryptography to secure ledgers and secure transactions, I think that that will start being used more and more by private institutions as well as potentially the government to make things more secure. We do need to worry a lot about cybersecurity. I think there’s a lot of value in blockchain. I just think that ICOs are too dangerous.

Luigi: Kate, we should rush to sell our Katecoin before you succeed in blocking all ICOs.

Kate: If you want to make Katecoin, be my guest. But I’m not endorsing this sort of activity.

‘Quitaly.’ ‘Italeave.’ Whatever you call it, Italy’s recent election results are stoking fears that the once staunch supporter of the EU may be the next country to exit. Kate asks Luigi, our resident Italian expert, how we got here and why it matters.

Speaker 1: The market is getting very spooked by what’s going on in Italy, and we know that-

Luigi: Hi. I’m Luigi Zingales at the University of Chicago.

Kate: And this is Kate Waldock from Georgetown University. You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Speaker 4: Italy officially becoming the next European country to deliver huge victories to far-right populist parties.

Speaker 5: The two biggest winners, the populist Five Star movement and the right-wing League, earned better than 50 percent of the vote.

Speaker 6: Some have said, in recent months, that the wave of populism is over, but it seems to be cresting again, at least in Italy.

Kate: On today’s episode, we’re going to be talking about Italy, its role in Europe, and the most recent Italian elections—whether we should be concerned about it here in the US. We really scratched our heads as to who we could have on the show to be an Italian expert. I think after some time, we realized that we’ve got our own expert right here. Also, what did you have for breakfast this morning?

Luigi: Avocado and grapes.

Kate: No prosciutto today?

Luigi: No prosciutto today.

Kate: Almost every time I talk to Luigi, he’s had grapes and prosciutto, which I think qualifies him to talk about all things Italy.

So, Luigi said something a couple weeks ago which really struck me.

Luigi: Yeah. I said for the European Union, the Italian elections were worse than Brexit.

Kate: That’s pretty crazy to me, because at least over here in the US, there was a ton of hype about Brexit when it was going on, and we’ve heard a lot less about the recent Italian elections. So, why is it so bad for the EU?

Luigi: There are two things that, in my view, can be worse than Brexit. The first one is this is an indication that a country that was super pro-Europe has turned around and become anti-Europe or Euro-skeptic. So you have to realize the that United Kingdom was always a marginal partner, at least in spirit, to the European Union. They joined relatively late, in 1973, and if you look at polls, the polls were always 50-50, 40-60 in favor of the European Union. So there wasn’t a sense that the European Union was really popular in the United Kingdom. Italy was a founding member of the European community that later led into the European Union. This was started in 1957 actually in Rome. The Treaty of Rome is the founding treaty of the European community. For the greater part of the last century and the beginning of this one, the support for the European Union in Italy was enormous. Like 80 percent of the people thought they benefit from being part of the European Union. This support, starting in the early 2000s, started to drift down. Recent polls are more like 50-50, and the vote gave a majority of the votes to parties that are anti-Europe. Not necessarily anti-Europe, but they are, let’s say, Euro-skeptic, if not anti-Europe.

The second is, this election could lead to what I prefer to call Quitaly, where Italy might leave the euro. By the way, according to the treaty, leaving the euro implies also leaving the European Union. So it will be similar to a Brexit but much more disruptive than the Brexit because it might involve the breakup of a common currency.

Kate: Right. This is a distinction that still confuses me, I’m a little embarrassed to say. Could you walk us through what you mentioned just now, the Treaty of Rome in 1957, but also how that led to the formation of the EU, as well as the eurozone and what the differences are between those things?

Luigi: Immediately after World War II, there was a very strong push to try to make France and Germany be allied to avoid what happened twice in the century, i.e. a major world war about the tension between France and Germany. The nutshell of what is now the European community started as a commercial deal, mostly between France and Germany, to make accessible to France some of the coal and steel in Germany, to make it more difficult for Germany to become powerful again militarily and start another world war.

That original agreement was formed by France, Germany, and then surrounding countries: Netherlands, Belgium, Luxembourg, and Italy. One of the big changes between the European community and the European Union was that when it became a European Union in 1992, it introduced also the free movement of people within the union. If you are an Italian, you can freely go and work in Belgium, and if you are from Poland, you can freely go and work in France. In the process, a lot more countries were admitted to this union, starting with Austria, that used to be a neutral country, and so on and so forth. Then, around that time also, some of the core countries signed a treaty called the Treaty of Maastricht to create a common currency.

Kate: So, to be clear, where the eurozone is the group of countries that adopt the euro, a single currency, whereas the European Union was just a broader set of countries with a centralized governing body that mostly oversaw ... What? Commercial deals? Trade agreements?

Luigi: The centralized part is very weak. We do have a European parliament, but it’s not very powerful. Basically, think about there is a commercial union that is called European Union, and then there is a common currency that is called eurozone. However, and this is important, in principle, the idea is that every country that belongs to the European Union eventually should belong to the euro. And, this is crucial for the discussion we’re going to have today, there is no way to exit the euro without exiting the European Union. So the two things, at least on the way out, they are connected.

Kate: So let’s go to Italy after the financial crisis. How has the economy been doing? What’s been going on politically since then? What are other factors that are leading up to the Italian election that just took place?

Luigi: So, the global financial crisis had, as a first-order impact, a strong reduction in international trade. Italy was hit by this much stronger than most countries. Just to give you a sense, German exports dropped by 10 percent. Italian exports dropped by 20 percent. The United States in 2009 had a recession, I go by memory, of 3 or 4 percent. Italy, 5.6 percent. So Italy was hit very, very hard. Then, by the time we’re slowly recovering, we are 2010, 2011, people started to doubt that the Italian government could actually pay its debt. Whenever there is a doubt like this in a country with an independent central bank but a sovereign central bank, the central bank tends to come to the rescue of the government. In the eurozone, this did not happen until late in 2012. In the meantime, Italy experienced a dramatic rise in interest rates, a fiscal crisis, had to cut the budget deficit in a major way, at the time we were just slowly recovering. It’s as if, let’s say, in 2009 the United States, instead of adding a gigantic stimulus package, had to cut their deficit by a huge amount.

That triggered a second recession that had a dramatic impact, also, on the stability of the Italian banks. Over the period 2008 and 2015, 35 percent of the loans to firms got into default.

Kate: That’s crazy.

Luigi: Three major banks basically collapsed, unemployment shot at 12 percent, and youth unemployment shot to 35 percent.

Kate: So what does this feel like for an Italian? Do you have friends and family who are really suffering from these two recessions?

Luigi: Yes. I have my parents. My father passed away in 2015, but at the time, both of them were alive. One of my concerns was, what happens if banks fail and they can’t buy food? One of my concerns was, I want to make sure that they have enough cash at home that if anything happens, they could actually go to the grocery and buy. The possibility of a generalized bank failure was not out of the feasible set. I have a lot of friends who lost their jobs and are unemployed or were unemployed for a long time. I have nephews and nieces who find it very difficult to find a job. I think the typical Italian of the generation of my kids looks forward to expatriating somewhere else. My son, who lives in the United States, got married at age 25, and when he announced this at the family gathering at Christmas, everybody thought he was joking. How could somebody at 25 support himself and actually start a family? In Italy, it’s inconceivable. Generally, you leave your parents’ house when you are 35. It’s not a coincidence that fertility in Italy is one of the lowest in the world. People don’t have kids, because generally, you don’t have kids when you stay in your mother’s house.

Kate: So, did Italy ever recover?

Luigi: Now, Italy is going again, but in 2017, people were celebrating that we grew at 1.5 percent after years of recession or growth below 1 percent. This is not enough, because Italy’s GDP, in real terms, is below what it was in 2007. We still have to recover from the beginning of the Great Recession.

Why the recovery was so slow, a number of things. One is we couldn’t devalue like, for example, the United Kingdom did to recover. The other one, which was quite important, is Italy had a banking crisis due to the fact that when you have 35 percent of your businesses defaulting, basically, it’s very hard for banks to stand. The Italian government found it very difficult to intervene in this banking crisis because there were a bunch of European rules that made this more difficult. That delayed the recovery in a major way. Now, the recovery slowly is taking place, but there is still a huge amount of discontent.

Kate: All right, so now let’s talk about the Italian political system and bring this to the recent election.

Luigi: First of all, it is important to understand Italy is a parliamentary system, not a presidential system, so our president is kind of the Queen of England—decides who to appoint but not much more. I’m exaggerating a bit for simplicity. What decides who rules is basically the set of parties, the coalition, who can get a majority in parliament. Traditionally, you could think about the party being divided into two major blocks. One called, not surprisingly, the Democrats, and very similar to the US Democrats. Another was a coalition of center-right parties, kind of the Republicans, but until very recently, led by Berlusconi, which is not that different from Trump. It’s just a kind of nicer version of Trump.

Kate: Then, more recently, I know that there’s been some turnover in your political system, but Matteo Renzi has been more powerful. He’s more of a Democrat, right? At least, more centrist?

Luigi: Yeah. In 2013, there was some elections in which the Democrat got a majority but not enough to rule. After some internal in-fighting, eventually Matteo Renzi, a young fellow, became the leader of the party and got a coalition with some of the conservatives in order to run the country.

Kate: Can we think of Renzi as like a Macron or a Justin Trudeau in Canada?

Luigi: Actually, the better example is Obama. If I may say, he turned out to be like Obama in that he was better at giving speeches than running the country.

Kate: Yikes. We’ll save that for a different discussion. So, then what happened?

Luigi: Two things happened. First of all, back in 2006 or ’07, a comedian, a professional comedian, started a movement. The first gathering of this comedian was a day that was called Vaffa Day that, I don’t know whether I can say it on air, but basically translated, I’m sorry to say, is ...

Kate: Just say it.

Luigi: Go eff yourself. This was basically a protest movement against the perception, and I will say also reality, of a country that was stuck with old politicians, old businesspeople, most of them corrupt. Just to give you a sense, the leader at the time, Berlusconi, was in his late 70s and had been in politics for more than 20 years. The largest banks were run by people in their 80s. The president of the republic was in his late 80s. It was what we call a gerontocracy. That is a fancy name to say ruled by old people.

Kate: A bunch of geezers.

Luigi: The great feature of this movement is it was appealing to both sides of the political spectrum. One some issues, it was more on the left side, like environment, like anti-corruption. On some issues, it was more right-wing. For example, concern about immigration.

Kate: All right, so I sort of like the idea of this guy. He at least sounds fun to listen to. Was there some expectation that he would actually do well?

Luigi: No, at the beginning, he was considered like a caricature, as you can imagine. He has a degree in accounting, which is something you don’t expect from a comedian.

Kate: From a comedian, yeah.

Luigi: But that puts him better than most politicians. Actually, the right example is like John Oliver. So imagine a John Oliver starts a political system.

Kate: So, what is this Five Star movement?

Luigi: The answer is we don’t know yet, but this is the interesting thing, is the movement, first of all, called itself a movement, not a party, because they try to be post-ideological. If you take away the jargon, they are trying to get people to express their opinions from bottom-up. So they tend to be less strict ideologically than most parties.

Kate: So in addition to Brexit, something that got a lot of attention in the American press was the refugee crisis from Syria, which involved a lot of provocative images of people washing up on beaches, boats full of people immigrating to Europe. To what extent has immigration and potentially anti-immigration sentiment been as strong in Italy as it was in England and Britain?

Luigi: It’s interesting that you mention Syria. You don’t mention Libya. There was a major refugee crisis from Syria that went through Greece and, eventually, to Germany. That was stopped by an agreement between the European Union and Turkey. There’s still an open crisis, actually, through Libya. Italy is at the front line of this crisis, and this is a crisis, you’ll be happy to know, that is not being caused by American interventionism. There was a major attack to Libya that destabilized the Libyan regime, and now, Libya is a failed state that favors illegal immigration to Italy. In case you don’t get your geography right, little Italian islands are very close to the shore of Libya, so there are a lot of people that make money by bringing potential immigrants to the border of the Italian sea border and then dumping them there and Italy rescues them. Then, this is the interesting thing. The European treaties say that if you rescue an illegal immigrant, that illegal immigrant must remain in the country that receives it. It’s as if all the illegal immigrants in the United States went through New Mexico, and New Mexico was responsible, out of the state budget, to pay all the costs of all the immigration. So Italians are mad about the situation, but they are not so mad against the immigrants. They’re mad against Europe.

Kate: Wait, but I thought the whole idea of the EU was that people could move freely between countries.

Luigi: Except if you are an illegal immigrant. The rules say if you’re an illegal immigrant, you have to remain in the country that accepted you. Of course, all this immigration created a huge resentment against the European Union that added up to the economic discontent. I want to be very clear: the economic discontent is not only the responsibility of Europe, but certainly, Europe did play a role. The rest of the role, I think, was played by the Italian establishment. The combination between the two created a perfect mix to have parties that are antiestablishment and anti-Europe to win the election.

Kate: OK, but as of right now, it seems like since no one has the majority, Italy is sort of stuck at a stalemate. Couldn’t this be good for the eurozone, then?

Luigi: Depends what you mean by good. Is it good in the sense that it postpones problems? Absolutely. It’s going to be more calm, and the markets seem to be very calm at the moment. I have to say that even Germany took six months to form a government, so it will not be surprising if it takes six months to form the Italian government. There is a possibility of new elections. So we don’t really know what is going to happen in the near future. The question is, can the eurozone reform itself in a way that makes it more viable for countries like Italy to be there? Or at some point, do we need to conceive a breakup? At some point, I conceive a breakup in which Germany will leave from the top. It’s much easier to leave a currency union from the top rather than to leave from the bottom. If Germany wanted to leave and create a northern euro, that I will label the neuro, it will be a strong currency and will make it much easier for the rest of the union to go along.

The problem of this is, seriously, where will France fall? This has always been the dramatic question in the European Union, because France is more like a southern European country than they want to admit, but they want to be in a coalition with Germany in order to avoid another world war. If Germany were to leave the euro from the top, France would be forced to either join the German currency union and basically destroy its economy or be with what they call, with a lot of contempt, the Club Med, and be with the southern European countries. I don’t think that any French president will allow that to happen, because it will touch their national pride.

Kate: It sounds to me, actually, like what happens in Italian elections don’t really matter for the eurozone or for the EU. If Italy is so screwed if you leave because that will trigger bank runs, which will just plunge Italy into another very deep recession, then, in some sense, you’re stuck. So Germany can just treat Italy however it wants, right?

Luigi: I think that we can look at the example of Argentina. Argentina was in a unilateral currency union with the dollar. For many years, the currency union worked very well. Then, there was an increasing problem in Argentina to export and an increasing problem in Argentina to pay the debt. All the governments have promised that they will never exit the currency, and eventually, they did, and they defaulted on the public debt. It took five presidents in two months to do that. It’s extremely politically disruptive, because the person doing it is not going to survive.

There is this famous line that if something is not sustainable, eventually, it will not be sustained. It’s not that deep, but it’s actually quite important in thinking about this thing. Is the euro sustainable for Italy long-term? I have my doubts. In many ways, the last few years have been the best possible world for Italy because interest rates were incredibly low, the euro, until recently, was relatively cheap vis-a-vis the dollar, and oil prices were quite low. The combination of these three, if you have to pick the best variables for Italy’s economy, those are the three variables. With this magic combination, we achieved 1.5 percent GDP growth. The upside, in my view, is limited. The downside is quite serious.

Kate: So, what should the leaders of Europe do, both the leaders of Italy after the most recent election as well as the leaders of the EU and the ECB?

Luigi: I think that in Italy, it’s relatively simple. Simple to say, very difficult to do. You need, really, to turn over the existing establishment. The message was very clear: Get out of the way. I think that, potentially, in terms of votes, the parties that won the election have the force to do that. Now the question is, it’s easier to send home people. It’s not easy to find qualified and competent and better people to replace them in a short period of time. I think that is their first mandate, and they should work on that. The second one is trying to do a good-faith effort in renegotiating the situation in the euro. For example, pushing for a European unemployment insurance, to me, should be a first priority. I think that negotiating hard on this, if they succeed, possibly, the situation is fixed. If they fail, I think they will have a stronger mandate to say, “You know, we can’t continue like this, so maybe we should think seriously about breaking away from the euro.”

The European leaders should pay attention. I think there was a sense in which people thought that you could govern Europe from Frankfurt. The perception was once we control the common currency, we can control the politics on all the European countries. I think the message from Italy is people are sick and tired of this. Part of the aversion toward the euro is that people are starting to see this game. So I think it’s very important for both the political authorities but also the monetary authorities to understand that the game has changed, and they have to change the way they play it.

Kate: So I don’t know if I speak for all Americans when I say this, but at the end of the day, I’m pretty selfish. I care about what happens here. So why should America care about what’s going on in Italy?

Luigi: I think for two reasons. First of all, if Italy were to exit the euro, probably the euro will break up in a major way. This will create economic and political turmoil in Europe with dramatic repercussions in the United States, as well. I think that just for those spillovers, you should care about it. Second, many people, after the 2016 election that brought a lot of populism to victory in the UK and in the United States—2017 sounded like a pretty stable year with Macron winning France and, in the Netherlands, the populist is not gaining too many votes, and in Austria, the right-wing candidate did not win, and so on and so forth. So people thought that was the end of it and things will subside. The Italian election suggests that, no, that people are upset. When they get to vote, they vote very strongly antiestablishment. In the grand scheme of things, the Five Star movement is not the worst thing that can happen, because they are pretty moderate in many policies, except for their anti-European bias. If they were to fail at the government this time, we could have more radical movements. I think that the easy way to manage Western democracy that prevailed for most of the period after World War II, I think is broken and is broken in Western Europe, is broken in the United States.

Kate: All right, well, Luigi Zingales, it was a pleasure having you on the show.

Luigi: Thank you, Kate.

10 years after dark pools of derivatives contributed to the Great Recession, former Commodity Futures Trading Commissioner Sharon Bowen tells Kate & Luigi how she helped bring transparency to the market and visited a few grain silos along the way.

Speaker 1: You know what, right now, breaking news here. Stocks all around the world are tanking because of the crisis on Wall Street.

Speaker 2: It was a historic day with Wall Street shaken to its very foundation today.

Luigi: Hi, I’m Luigi Zingales, at the University of Chicago.

Kate: And I’m Kate Waldock, at Georgetown University. You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Kate: On today’s show, we have the great pleasure of welcoming Sharon Bowen. Sharon served as the commissioner of the US Commodity Futures Trading Commission, or the CFTC, from 2014 to 2017. Before that, she was vice chair of the Securities Investor Protection Corporation and before that, she was a partner at Latham & Watkins. Welcome to the show.

Sharon Bowen: Thank you, thank you for having me.

Luigi: Let’s start by going back to 2008. In September of that year, the world was coming to an end. On Monday, Lehman filed for bankruptcy. On Tuesday, AIG asked for the government to rescue them.

Speaker 6: What in the world is happening on Wall Street?

Speaker 7: Two-year note yields went from 190 to 166 in the blink of an eye.

Speaker 8: I have never, live, looked at the DOW Jones Industrial board and seen a 600-point loss.

Speaker 9: Who knows where this is going to end up? This is volatility we haven’t seen of course, since way before you and I were born.

Speaker 10: By what Warren Buffet once called financial weapons of mass destruction.

Luigi: Sharon, when was the first time in that ominous fall that you got a sense that this was really big and this was really scary?

Sharon Bowen: I would say it was the weekend before, I was starting to get emails to basically say don’t be surprised if you see numbers being thrown out about some investment banks being sold for $2 or some of them possibly going out of business. There were a lot of rumors over that weekend. When I woke up that morning and just saw the market just go straight, straight down, it was scary. It was absolutely scary, and I don’t think any of us really knew what it really meant. We just knew it was really bad. It was really, really bad. And you saw the pictures on the news of people packing up their boxes, businesses closing down, the restaurants that used to rely on the businesses to come to eat lunch were closed, and the dry cleaners that used to clean were closed. The taxi services and car services that used to be there closed.

Being in New York City, I saw sort of the ugly parts of the financial crisis pretty much up close and personal.

Kate: Are you allowed to talk about your clients at the time, and whether any of them were particularly affected by what happened to Lehman and AIG?

Sharon Bowen: Well, all of them were affected obviously. Lehman had been a client of my former firm.

Kate: Oh, wow.

Sharon Bowen: We knew people who actually worked there.

Luigi: When you were invited by President Obama to serve on the CFTC, did you feel like a sense of mission that here we are many years later, and we tried to prevent what happened in 2008 and as we will discuss with the listeners in a second, the CFTC plays an important role in preventing a repeat. Did you have a sense of mission?

Sharon Bowen: I did, but it actually started with my being the acting chair of SIPC, Securities Investor Protection Corporation. SIPC traditionally is a sleepy organization, but during my time, we had the Lehman Brothers bankruptcy, we had the Madoff scandal, we had MF Global. We had some of the most notorious–

Luigi: An easy time.

Sharon Bowen: Yes, and through that lens, I got to meet with many investors who were severely harmed financially from the marketplace, and as I mentioned before, seeing the devastating effects on family members and people’s retirement savings. I actually did, I really felt a calling to do it, plus as it turned out, I was the first African-American commissioner of the CFTC.

Kate: That’s amazing.

Sharon Bowen: It was quite an honor to play in that role, but as I said then at the time of my confirmation hearing, that I wanted to be a voice of the voiceless, those who traditionally had never had a seat at the table.

Luigi: That’s exciting because most people probably don’t know what the CFTC is, and you said giving a voice to the voiceless, and when people think about giving a voice to the voiceless, I don’t think they think of the CFTC as the primary place, but I think it’s a very important role. How do you explain to your kids, to your mother, to your friends what is the CFTC and why it was so important what you did there?

Sharon Bowen: There are two different ways that I explain it. For the everyday person, I try to explain how the electricity in your home, your heating bills, the gasoline you put in your car, the milk that you drink, everyday products are financed through instruments that we regulate in our commodities markets. We have our roots in agriculture. Initially, the CFTC really started as a means for farmers and ranchers and manufacturers to hedge against the future prices of products, so it’s a way for farmers and ranchers to mitigate the fluctuation of prices going up and being able to lock in today the price of a particular ingredient so they would have some certainty in terms of that price.

For other people, I will sometimes say it’s things like how much you pay for your mortgage. Interest rates, everybody’s tied to it, credit default swaps are tied to it, financial currencies are tied to it, so they’re financial instruments and obviously, derivatives, some of them a little bit more esoteric instruments, but again, they’re used for hedging.

Virtually every corporation uses it. Everyone is really affected by it, frankly, every day.

Kate: You gave the example of let’s say a farmer using commodities futures or derivatives to hedge the future price of some input, let’s say it’s like feed for their livestock, but one of the dangerous things about derivatives, correct me if I’m wrong, is that you don’t have to be a farmer in order to buy let’s say those derivatives. You could be like a regular person. It could be me, and if I want to take a bet on the price of feed going up, I could buy a derivative that will pay off if it goes up by a lot, and if it goes up by a huge amount, in let’s say like an unlikely event, chances are I won’t have to pay much to take that bet. Is that part of what makes derivatives so risky?

Sharon Bowen: Well obviously, there is speculation in our markets. You’re correct in the sense that we did hear, while I was at the agency, from some of the farmers and ranchers who really were concerned about the volatility in their markets and who thought that the high-frequency traders were in their markets and making price discovery much more difficult for them. Whenever we hear things like that from end users, we take those kinds of things seriously. We take a look at the markets, but speculation in and of itself is not bad. That is part of price convergence and price discovery, but it’s the excessive speculation and the manipulation of the market that we protect against.

Kate: By end user, you mean people who are truly using derivatives in order to hedge against risk, right?

Sharon Bowen: Correct.

Luigi: It will be useful to de-mystify the term derivatives, because people use it all the time and many listeners might say, “What exactly is a derivative?” Now, a derivative takes its name from the fact that there is a security whose payoff derives from the payoff of something else. If you own a house, hopefully you have insurance on that house and that insurance is a derivative because the payoff of that insurance derives from the payoff of the house. In that particular case, the insurance is a hedge, it protects you against the possibility of fire, earthquake, something that might destroy the value of what for many of us is the most important asset, which is your home.

Like for insurance, there are many derivatives that are meant to hedge, to cover the risk of what people do, from people planting in their harvest, to people using livestock to feed their animals, and so on and so forth. However, as Kate pointed out, in order for the market to work properly, you don’t have only hedges, you have people that provide the service with the hedges that have the terrible name of speculators, and those speculators in part serve to make the market liquid, in part may actually destabilize the market.

In the last 10 or 15 years, the number of participants in these markets has increased dramatically. And especially in many commodities markets, there used to be mostly final users, and around 2004-2005, we saw an impressive entry of the typical financial institutions, the Goldmans and Morgan Stanleys of this world, and not surprisingly, the final users started to complain because the volatility went up. What is your view on that, if you have one?

Sharon Bowen: Right, well see, taking it to the extreme, we can talk about the financial crisis, when in fact, we were not regulating those derivatives. We had no idea what was happening in those dark pools in the market, and as a result of the financial crisis, as you know, the Dodd-Frank Act came into place, and that expanded greatly the powers of the CFTC to regulate the so-called derivatives, the esoteric transactions that clearly exacerbated the financial crisis at the time. With that, extensive rules were put into place to require, for example, capital to be there that normally was not required by some of the financial institutions.

We required that they be cleared in a much more transparent way and executed on platforms. For the swaps and derivatives that were not subject to what we would call margin, we made sure that the cost of capital was even higher, so we really wanted to force onto a lit exchange those very transactions that were really dark and opaque. We had no idea what they were at the time. Through Dodd-Frank, we were able to bring some transparency to the market and to try to mitigate the systemic risk that those kinds of instruments really posed.

Kate: To clarify what you just mentioned about clearing, which was an important part of Dodd-Frank, yes, there were a lot of derivatives that were cleared prior to the financial crisis, but there were some derivatives that were sort of operating in the shadows. Let’s say I was a speculator and I wanted to just make some money by making a bet that locked in the future price of let’s say corn feed. If I were to make that bet one-on-one with my investment bank prior to the financial crisis for certain derivatives, the government might not know about it at all. This could’ve just operated in the shadows.

Part of what clearing did was not only to bring these transactions into light, make sure that somebody was monitoring them, but clearing or clearinghouses also make sure that whoever was taking the other side of the bet, whoever would have to pay out in the future, potentially, has enough money on hand, enough capital in order to meet let’s say what would happen if I were to receive some money in the bet. Is that an accurate way of describing the role of clearinghouses?

Sharon Bowen: That’s a really good job of it, I think. To bring onto the markets those transactions that were otherwise opaque. Most of those that got us into trouble were the credit default swaps and interest rate swaps and those kinds of transactions that were kind of off-exchange. You’re correct, one of the mandates was to introduce central clearing of standardized products into the market, and because of that, I mean at that time it was something like a $700 trillion notional amount market. It was a huge market that we really, frankly, didn’t know how big it was.

We have now created a whole new structure where these transactions take place in clearinghouses, and those transactions as you say are subject to margin, which is collateral, i.e. cash or highly liquid instruments to support the payment of those obligations. The clearinghouse stands in the middle of the buyer of the trade and the seller of the trade if you will, they stand in the middle and their job is to mitigate the risk that the trade would fail. That’s the purpose of the clearinghouse. Whereas before, people had to depend on each other’s credit as to whether or not they were worth the transaction.

That was the major difference in bringing clearinghouses and the transparency. At the same time, the participants in the clearinghouses were required to be registered. The third thing that happened was data had to be reported.

Luigi: Sharon, you mentioned the magic word, credit default swap. This word was unknown to the large public until 10 years ago, when it became a matter of conversation all over the country because they were one of those derivatives that might have caused or exacerbated the financial crisis. Let’s first explain what they are: credit default swaps is basically nothing else than insurance against the possibility that a borrower may default and not pay the actual amount. Instead of being an insurance written by an insurance company, it is actually an instrument traded on the market.

Here, I need to bring you back to history because historically, the CFTC did not have any authority to regulate these kind of derivatives, and a very courageous woman, Brooksley Born, in ’98 tried to actually ask for the authority to do so because she realized that these instruments were traded over the counter, which means between banks, and there wasn’t really a good understanding of what was happening, and in particular, there was a fear that too much risk was taken and this risk might materialize as it unfortunately did in September 2008.

When she insisted that, she found herself surrounded by a bunch of angry men, can I say that, starting from the Federal Reserve chairman at the time, Alan Greenspan, to the Secretary of the Treasury at the time, Larry Summers, and they actually said that this was a terrible idea and made everything possible to stop this from taking place, and so she ended up resigning. Did I tell the story correctly, Sharon?

Sharon Bowen: I wasn’t there at the time, but as I understand the story, you’re right. Former commissioner Born was one of the first to signal the problem that could be inherent in these types of products. My understanding at the time was that some of the other potential regulators, the Fed and the Treasury, thought because the transactions were between highly sophisticated investment banks trading with each other, they were sophisticated enough to be big boys playing in the same field, if you will.

Luigi: Yeah, you used the right term, big boys.

Sharon Bowen: Right.

Kate: One of the, I guess, concerns I think voiced by Greenspan and Summers and others against bringing these sorts of derivatives and swaps onto centrally cleared exchanges was that there’s some cost to having to do that, correct? You have to pay some sort of fee. You aren’t allowed to operate privately anymore. Also, you have to comply with the rules of the clearinghouse or the exchange. I think one of their concerns was that if the US started imposing these rules, a lot of these transactions would go offshore to potentially riskier domiciles. Do you think that that’s actually a legitimate concern?

Sharon Bowen: It was a concern and, you know, as a result of the financial crisis, we had the meeting of the G20 in Pittsburgh, which is really sort of the beginnings of the creation of Dodd-Frank, where the major financial centers and countries said, “We need to work together to make sure that our markets are protected globally,” because these markets are global markets, the transactions don’t stop at our borders. It’s really important, and at that time, a number of working groups, international working groups were formed to try to create standards across jurisdictions. I think our agency at the time with the CFTC, and I’m sure it’s the case today, works really closely with international regulators, particularly those in Europe, where things like interest rate swaps and CDSs are traded in a large percentage outside of the US.

You’re absolutely right, it was expensive. Industry did have to invest a lot of money, but I think it was well worth the cost to mitigate the kinds of risk that we would have such a devastating effect again. At least with the margin, having margin there and collateral—sort of the two defenses, if you will, to a failure of a clear member—that, I think, gives us the possibility that we’re less likely to have another taxpayer bailout, which was the whole point.

Luigi: Some people, not of course all, but some people interpret the cost benefit analysis as, I see a cost, I don’t see benefits, let’s get rid of all of it. That, of course, is wrong. It’s also wrong that any regulation is useful because as we were discussing earlier, there are a lot of pieces of regulation that are more burdensome than useful. Cost benefit analysis is useful, but it’s challenging, and particularly when the benefit is preserving the trust of investors in the marketplace, which–

Sharon Bowen: It’s priceless.

Luigi: It’s priceless, exactly.

Sharon Bowen: Yeah, it really is priceless. I mean you do want to have investors have the confidence to be in our markets. If they think it’s a rigged system, that’s not a good system. I think that transparency is always the key. Having fair, transparent markets, as long as we can keep our markets fair and transparent, I think you’ll have investor confidence. That works for all participants, not just investors, but competition is competition. The brokers, they compete against each other so they’re not going to want to see one person game the system over someone else either. They want to see a level playing field.

Kate: I want to switch gears, if I may. If I’m correct, when you resigned from the CFTC, you cited your lack of ability to form a quorum amongst commissioners as part of the issue. In order for there to be a quorum, there’s supposed to be five commissioners, there have to be three for there to be a quorum, but there were only two commissioners that were even standing at the time that you resigned, right?

Sharon Bowen: When I left, two new commissioners were in place. In June, I had announced my intent to resign, I didn’t give a date certain. Part of my announcement of my intent to step down was my hope was that I would add a little pressure if you will to Congress because if I left, it was questionable how much chairman Giancarlo could do by himself. And you’re right, it should be a five-person commission, and whichever party is in charge in the White House gets to pick the chairperson of the agency, and the majority would be three Republicans, two Democrats.

I can tell you, my experience is the CFTC is not a partisan agency. There is no Republican answer or Democrat answer, it’s that we all are trying to achieve the right answer. During the time I was there as a commissioner, I think the number of times that all of us voted unanimously was like over 95 percent. For the most part, we pretty much reached consensus.

Luigi: Should we take from this, I don’t want to put words in your mouth, but should we take that maybe some of this anti-regulatory stand that we hear in the newspaper that seems to destroy this is a bit excessive? That in reality, this is a normal process of pendulum that after a crisis, you tend to regulate and when you regulate, sometimes you tend to overdo it, and then you go a little bit back and you try to find what is really important and dismiss the parts that might be excessive or excessively burdensome?

Sharon Bowen: No, I think that’s right. Also, not just us, but the Europeans with MiFID II, they’re also going through a review of their rules to see how they can make their rules better at the same time but yes, no, you’re absolutely right, and that makes sense. These rules are complicated. Some of them did have unintended consequences that we really attempted to try to eliminate those cases where we were putting undue costs and burdens on particularly end users who were not posing a systemic risk to our market. The kinds of changes we made were to try to correct some of those unintended consequences.

I think at the same time, the industry is fully invested in the protections we now have in place and you would be hard-pressed to find, you’ll find them complaining about the cost but you’d be hard-pressed to find one who would not say that we’re not better protected today than we were before 2008.

I think that makes us more competitive. In fact, some of them will tell you, that makes us more competitive and it makes our financial markets, frankly, the envy of the world because in fact, our markets are safer.

Kate: But there are still derivatives out there that are relatively opaque, right? There are derivatives that aren’t cleared, particularly ones that are more complicated. Is there any way to know whether they pose systemic risks?

Sharon Bowen: All swaps, whether they’re cleared or uncleared, are reportable and subject to margin, but are there dark pools out there? I’m sure there are dark pools that are out there but-

Kate: What is a dark pool exactly? Can you just define that really quickly?

Sharon Bowen: Yeah, that’s off-exchange. I call it dark because it’s not on an exchange—there’s no transparency, which is why it’s dark. I’m not sure why it’s a pool, it could be a park.

Luigi: The name sounds very ominous but why are you afraid of those dark pools?

Sharon Bowen: We got bit by one in 2008. It was like an avalanche. It hit us in a way that we had no idea, it was a pretty bad bite. We should all be afraid of dark pools.

Luigi: I think then the major problem is you don’t see them coming because-

Sharon Bowen: Correct.

Luigi: The reason why they’re called dark is because you don’t see the data, and transparency is a big help in those situations.

Sharon Bowen: Yes, absolutely.

Luigi: Going back to the decision-making process, you are saying that there is a procedure of course ...

Sharon Bowen: Yes.

Luigi: ... where you hear all the sides but one of the concerns is banks have very good lawyers and lobbyists that are representing their side, and farmers and individual users are not as well-organized and they tend not have good lawyers and good lobbyists. What do you do to-

Sharon Bowen: You’d be surprised by that, actually.

Luigi: How do you make sure that you’re not fooled by this imbalance? It’s kind of you are a judge in which on the one hand, you have a slick lawyer, on the other hand, you have somebody defending himself?

Sharon Bowen: Right. Well, it’s interesting, so all three of us had Wall Street backgrounds, and none of us had an ag background. And so we all met the farmers and ranchers. We went out to the grain elevator here outside of Chicago, we made trips to see the whole process, which really, frankly, I encourage everyone to do that. You will view food a lot differently after you go through that-

Kate: Can you just show up at a farm and ask to be on a grain elevator?

Sharon Bowen: It’s a lot more sophisticated than you can even imagine, the use of GPS and the use of technology to tell you how often to water. I mean it’s just fascinating, but because of our financial backgrounds, I think people were, they knew they couldn’t pull the wool over our eyes, frankly. We had represented some of them in past. We had the business background and Giancarlo also had represented the wholesale markets, former chairman Massad had worked on derivatives when they first started, as I did too in my career. So we were pretty familiar with the financial part of it, so there was no hocus pocus with firms being able to pull a fast one on us.

Kate: The Intercontinental Exchange, ICE, isn’t that one of the clearinghouses that regulates derivatives?

Sharon Bowen: They do have a couple of the clearinghouses that we regulated at the Exchange.

Kate: With all due respect, are you concerned at all about going from the CFTC to a clearinghouse that you were formerly regulating?

Sharon Bowen: Yeah, so the way I would view it is, I bring a level of expertise, obviously as a board member, I’m not a part of the management with the day-to-day operations of any of the subsidiaries. Frankly, the things I’ve always stood for, transparency, which is really key, investor protection, those are the kinds of traits and qualities that ICE really stands for.

Luigi: I suspect you’re probably one of the toughest customers on that board.

Sharon Bowen: That’s correct. It takes guts for someone to want to have a former cop on the beat, if you will, on your board, it means you have confidence in your operations.

Kate: Sharon, I have a term for you, it’s a little bit of a jargony term: you’re a BAMF POC boss lady, which is a very specific economics term that stands for badass mofo person of color, extraordinary woman.

Sharon Bowen: Oh, OK. That’s a good one.

Kate: Yeah, it’s a term that we throw around a lot in academia.

Sharon Bowen: OK.

Kate: I wanted to ask you if you could tell us a little bit about how you got to where you were, what the toughest parts of your journey were, and also whether you have advice for young women and young people of color for how to make it in law and finance?

Sharon Bowen: That’s about three books that you just asked me.

Kate: OK.

Sharon Bowen: I can give you-

Kate: Well, can you give it to me in two minutes?

Sharon Bowen: I can give it to you in two minutes. I had an interest in markets pretty early on in college. Majored in economics at the University of Virginia. Didn’t know what I wanted to be when I grew up. Applied to business school and law school. Northwestern and the University of Chicago were the only two schools that gave me full scholarships to both the business school/law school. Went to Northwestern for law school/business school.

Luigi: Sorry you made the wrong choice.

Sharon Bowen: Yeah, you know, what can I say?

Kate: It’s pretty rare.

Sharon Bowen: Yeah.

Kate: I mean I’d never heard of anyone who had a full ride at both.

Sharon Bowen: Yeah. No, I got academic scholarships to both schools, but wasn’t really sure what I wanted to do. I spent summers at Goldman Sachs, Chicago Board of Trade. Started my career at Davis Polk & Wardwell. Like most young people, thought I’d work for two years, retire at the age of 30 at Goldman Sachs. Loved the practice of law a lot, and as a fifth-year corporate associate, as Latham was growing its New York office, became a partner, had great clients, great work. Just really fortunate.

The advice I would give to people is to follow your passion in terms of the things that motivate you to want to get up every morning, and treat it like a marathon.

Kate: Well Sharon, it has been a great honor and a great pleasure having you on the show. I learned a lot today about the CFTC. I think I maybe understand what it does now.

Sharon Bowen: Pleasure to be here.

The U.S. economy may be booming, but despite a recent uptick wage growth remains stubbornly flat. Kate & Luigi examine the effect of monopsonies in the labor market among concentrated industries like Big Tech. Are companies colluding against workers and driving down wages?

Academic articles

- Labor market concentration is pervasive and associated with lower wages:


News articles:

- On the decline of labor mobility:

- Personal emails between Steve Jobs and Eric Schmidt about poaching:

- Fast food no-poach agreements:

- Some statistics and opinion on non-competes:

Speaker 1: 200,000 jobs added last month. That’s a big number. The bigger headline though is that paychecks, wage growth, is way up, and it’s the fastest pace we’ve seen in years.

Luigi: Hi, this is Luigi Zingales, at the University of Chicago.

Kate: And I’m Kate Waldock, at Georgetown University. You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Speaker 4: I mean, if you’re somebody who is working in this American economy, you want your wages to go higher. So yes, we saw wages increase at the fastest pace as we’ve seen since the recession, since eight years ago.

Speaker 5: The wage growth number, it looks like we’re finally starting to see a tight labor market give workers more bargaining power.

Speaker 6: The wage growth jumped from 2.5 percent to 2.9 percent. That’s a huge jump, and you can attribute that for a couple of reasons. For one, the tax plan. We saw dozens of companies hand out raises and bonuses …

Kate: All right, I think we should slow down for a second. The fact that there has been a slight increase in wages over let’s say the past month or two has been encouraging for some of us. But for those of us who have been looking at long-term wage stagnation over the past couple of decades, I don’t think it’s time that we can celebrate yet.

Luigi: What is interesting, of all people, the ones who are concerned about wages not growing enough are central bankers: the head of the Federal Reserve, the head of the European Central Bank, the head of the Bank of Japan. Why are they concerned? Because they have some inflation target to reach, which is 2 percent per year. Without some wage pressure, they cannot reach that target. The irony is, you think about central bankers as always being on the side of trying to keep the wages down. But now, they are wondering themselves: what is keeping wages down?

Kate: I think also another part of this story is that low wage growth has been juxtaposed against pretty high corporate profits. This has been an issue for a lot of advanced economies, not just the United States.

Luigi: So the question we’re trying to understand is why that’s the case. We need to understand first how wages do rise in general. The idea is, when there is a booming economy and firms are looking for more employees, they start to bid up the wages of people who are employed in other places, or they are unemployed and they need to get in the labor force, to attract more people to work. This is the fundamental law of demand and supply. When demand for labor is increasing, as it is now in most parts of the world as a result of a continuing expansion, then you should see a rise in wages as well. The puzzle is that we don’t see that enough. Just to give you a sense, from 2009 to 2014, wages went up only by 8.7 percent, when inflation went up by 9.5 percent. So the real wage-

Kate: Is that in the US or globally?

Luigi: In the United States, yes. So the real wage of a US worker during those five years went down, rather than up, in a phase in which the economy was expanding.

Kate: What could be one reason for these wages going down? As you just mentioned Luigi, we have in mind this model of employers competing with one another. Maybe that’s not the case. In some markets, maybe there is only one employer. The fact that there’s only one, or only a couple employers not perfectly competing with one another, could mean that they have power over labor, or they have power over people that they’re employing, and therefore they can keep wages low.

Luigi: Let’s introduce this name that is not probably familiar to many listeners, the term of monopsony. Many people understand what a monopoly is. There is only one producer. Monopsony is when there is only one buyer. In particular, we’re interested about when it’s only one buyer of labor. In this extreme form, this is relatively rare. People have in mind the famous mines in West Virginia, company towns in West Virginia where the mine was the only source of employment. Or they might remember an old movie, maybe it’s too old for you Kate, It’s A Wonderful Life, where-

Kate: Oh, that’s a classic-

Luigi: ... in the little town ... It’s a classic, yeah, so even you know that.

Kate: Even I know that movie.

George Bailey: Just remember this, Mr. Potter, that this rabble you’re talking about, they do most of the working and paying and living and dying in this community. Well, is it too much to have …

Luigi: This guy Potter, who owns everything in the little town where the corporate bank of Bailey and Company is operated.

George Bailey: ... well, in my book he died a much richer man than you’ll ever be.

Mr. Potter: I’m not interested in your book. I’m talking about the Building and Loan.

George Bailey: I know very well what you’re talking about. You’re talking about something you can’t get your fingers on, and it’s galling you. That’s what you’re talking about, I know. Well, I’ve said too much. I ... You’re the Board here. You do what you want with this thing. There’s just one thing more, though. This town needs this measly one-horse institution, if only to have some place where people can come without crawling to Potter. Come on, Uncle Billy.

Luigi: So I think that this extreme form is rare. But in the last two decades, the concentration of industry in the United States has gone up. As a result, in many towns, especially rural towns, the potential employers are few.

Kate: Yeah. When we think about monopolies, we usually think about a global, or a countrywide marketplace for something. But when it comes to monopsonies, or companies that have buying power over labor, we also have to factor in people’s limited willingness to move around. The United States is not what economists would call a completely frictionless labor marketplace. If I’m working in New York, and a similar job opens up that pays a dollar more per hour in South Dakota, it’s not a very obvious decision that I’m going to pick up and move to South Dakota. People, for family reasons, for personal reasons, for issues of the fact that it just costs money to move, it’s hard to move around. Often times, people just want to stay in the same place.

This means that monopsonies can exist on a very local level. So even though within a particular industry there could be a few, or many firms that hire people, in small localities, let’s say a town or a county, you can still have companies that are the only employers in a particular market.

Luigi: The point you’re raising, Kate, is very important. Mobility in the United States has gone down. People are discussing what the causes are, but I think it’s a combination of factors. One is the fact that now there are more dual-career families, so if your spouse is employed, and well employed in a place, you are more reluctant to move, because you have to break up the family. The other is that in many places in rural America, people are stuck with houses that are worth much less than what they paid for them, and sometimes they can’t even sell them at a positive price. Moving to a different location might cost them a fortune.

We know that the market for buildings in cities like San Francisco or New York is not very competitive. There are restrictions to entry, and so on, and so forth. It costs so much to rent an apartment in New York that you might not want to actually move to New York, even if in New York you have a better job, and better pay.

Kate: All right, so we have set the stage, but what we are here to do is to figure out whether companies having market power over labor actually plays a role in keeping wages low. Before we move on, I think we should insert a quick caveat, that we’re not trying to answer the whole story about why wages have been stagnated. There’s a bunch of different variables that go into this. Part of the solution, or part of the reason could be globalization. Part of it could be the way that labor contracts are written. There’s a bunch of different explanations for this. We’re not going to try and address the whole picture. We’re just going to focus specifically on employer power.

Luigi: We know that concentration of industry in the United States has gone up. Unfortunately, we are discovering that in an increasing number of cases, the bidders do collude. The most egregious of these cases is actually the one that was brought out by litigation a few years back, the one that affected Google, Apple, and other tech firms in the Silicon Valley, that was filed in 2010. Now you don’t think about software engineers as employees that have particularly low wages, but it is important to look at this case, because we have some smoking gun emails about the existence of this no poaching list, in which you are not soliciting the employees of the other group.

Let’s read one of these exchanges, just to set the facts straight. In early March 2007, an employee of Google made what was considered a career-ending mistake. She cold contacted an Apple engineer by email, violating a secret, and by the way illegal, no-solicitation agreement between the two firms. Now let’s read what the exchange between Steve Jobs and Eric Schmidt, who at the time was the CEO of Google.

Kate: OK, so I’m going to read one. This is by Steve, to Eric, “Eric, I would be very pleased if your recruiting department would stop doing this. Thanks, Steve.”

Luigi: After receiving this email, Eric Schmidt immediately sent an email to the top HR person at Google. In this email he said, “I believe we have a policy of no recruiting from Apple. This is a direct inbound request. Can you get this stopped and let me know why this is happening? I will need to send a response back to Apple quickly, so please let me know as soon as you can.” Just for context, in this email Eric Schmidt admits that there is an illegal restraint of trade, and is actually enforcing this agreement by asking his HR people to figure out why they violated this agreement. He wants to report to Apple that they are behaving well.

Kate: Then finally, one of the senior staffing strategists is really apologetic. He writes back to Eric, “Please extend my apologies as appropriate to Steve Jobs. This was an isolated incident, and we will be very careful to make sure this does not happen again.”

Luigi: Schmidt eventually writes to his friend Steve Jobs, “Steve, as a follow-up, we investigated the recruiter’s action, and she violated our policies. Apologies again on this, and I’m including a portion of the email I received from our head of recruiting. Should this ever happen again, please let me know immediately, and we will handle. Thanks.”

Kate: Then they sent back and forth some smiley faces.

Luigi: If you have this image of capitalists conspiring against workers, this is a pretty good exchange.

Kate: In fact, they were sued. This was one of the first major cases brought by the Department of Justice against a consortium of firms for colluding against labor, essentially. The name of this lawsuit, I’m not sure if this is official or colloquial, but the name of this lawsuit was High-Tech Employee Antitrust Litigation. It involved, as you said, several other tech firms. The original amount of the damages was on the order of about $3 billion. That amount, if the plaintiffs had won, could have increased up to $9 billion.

At the end of the day, the whole case was settled, originally for what was supposed to be $325 million. A judge stepped in, which by the way, in this sort of case is pretty rare, to say that that number is not high enough, that the plaintiffs actually need more in the settlement. So the final settlement number was $415 million, which may sound like a ton of money. But it only translated to a few thousand dollars for each of the claimants.

Luigi: What is important to stress is, this is a case in which there was a smoking gun. The emails that we read are pretty clear on the existence of this. If the worst that can happen to you when you’re caught with your pants down is to pay one-sixth of what you will have saved by colluding, the incentives to collude are pretty high.

Kate: I do think from a legal perspective, prior to this case, I don’t think there was a whole ton of precedent that the collusion by Apple, Google, etc., necessarily violated the Sherman Act. But I think after this case, I mean, it sparked a revolution essentially against these sort of non-poach agreements. Ever since then, there have been several other class-action lawsuits that have popped up, to the point where the Department of Justice in 2016 issued a statement for HR professionals, saying that this type of non-poaching agreement is explicitly illegal. So I think that there is room for a little optimism. Things are changing.

Luigi: I think that things are changing. But there is explicit pressure from the political system to make a change. Senator Cory Booker of New Jersey wrote a letter at the end of last year challenging the federal antitrust officials to be more active on that front. I think that traditionally, the antitrust has focused mostly on the product side, not on the worker side. I think that these anti-poaching agreements are clearly, in my view, a restraint of trade, and the antitrust should be more active on those.

Kate: Can I just be the devil’s advocate for a second here though?

Luigi: Please.

Kate: There is something that doesn’t really fully jive with me, in terms of how this whole thing is working, which is that you can either have monopsonistic power in high-skilled labor marketplaces, or low-skilled labor marketplaces. In both of those marketplaces, it doesn’t really make sense to me that there is necessarily a problem, because on the high-skilled end, I mean even though the plaintiffs involved, I’m sorry the defendants involved, in this high-tech case were Google and Apple and etc., I’ve been to the Google office in New York. I’ve been to some of these ... I mean, like the Facebook campus in Palo Alto. These places are essentially playgrounds for adults. They have ball pits, and they have perfume making stations. Life is pretty rosy. They’ve got famous architects coming in, making sure there’s grass growing from the walls. If these were truly monopsonistic employers, then we shouldn’t see all of these perks in these sorts of jobs. So on one hand, I feel like on the high-tech side, it doesn’t make sense that these employers are keeping wages down.

On the low-skilled side, by definition, low-skilled labor can transition more easily into other types of jobs. So if you are working for a fast-food restaurant, it may be relatively easy for you to transition to working as a driver, or for some sort of delivery service. Therefore, employers don’t have as much power over you. So where is this actually happening? It’s hard for me to imagine.

Luigi: It’s funny you mention, because one place where it does happen Is probably for young assistant professors.

Kate: Oh yeah, that’s for sure.

Luigi: Don’t you notice that everybody is paid roughly the same price at entry? The same price could be the result of two things: either a perfectly competitive market, or a perfectly colluded market. I would not be surprised if the deans of the top schools had some informal conversation about where the market is going, to basically de facto fix a price at entry. I think this is much more diffuse than you think it is.

Kate: I don’t know, I mean I would love for someone to negotiate on my behalf a higher wage, but to be honest, I think that at least in my field, at least in our field, wages are more than fair.

Luigi: I agree. I’m not saying that we’re underpaid in any possible form or shape. But I’m saying that at entry, there is some form of tacit collusion to agree on the same wage, which is an anti-competitive practice. While this may not be a major issue for a well-paid professor of finance, it is an issue, for example, for nurses. You talk about specialized labor, or low-skilled labor. I don’t know where you put nurses, but certainly they are specialized—

Kate: I think they are considered high-skilled.

Luigi: They are high skilled, but they are not very highly paid, to be honest.

Kate: Yeah.

Luigi: One of those legal suits that were brought is precisely in the direction of ... It was in Detroit, where there were only a few employers, and they seemed to collude in keeping down the wages of nurses. You mentioned fast food. Actually, there are now explicit anti-poaching agreements among franchises of McDonald’s. So you can’t compete with other franchisees of McDonald’s, to hire their workers. I consider this also restraint of trade. It seems like this is a pretty diffuse practice among franchisors to do that with their franchisees.

Kate: Yeah, I think this is another interesting case. So to be clear, fast food restaurants have these anti-poaching agreements within the same company. For all of McDonald’s franchises, they’re not supposed to poach labor from other McDonald’s restaurants, even if they’re located in the same region. So there’s a case is currently in court right now. I think the plaintiff is fighting really hard to not have the case dismissed, but that’s still ongoing. As a result of the case, even though McDonald’s is not going to want to pay up, they have removed these anti-poach agreements. So again, jurisprudence is moving us in the right direction.

Luigi: Yeah, but it needs to be nudged, because without the nudging, it will not operate. You’re right that you can consider these people as part of McDonald’s, but they’re not really, because those are independent franchisees, so technically they are not employees. As the number of independent contractors increases, the risk of these anti-competitive agreements increases as well. If I’m a driver of Uber, I’m an independent contractor. I’m not an employee. But can Uber restrict my ability to be a supplier for Lyft as well? As far as I know, they don’t do that. In fact, when I take Lyft or Uber, I ask, and many are providers of both. But suppose that they were to do that, then that is in my view a restriction on trade, because if you are an independent contractor, you are independent. You can do whatever you want.

Kate: I think the independent contractor issue is slightly different. It’s a whole separate reason for why wages may be low, but I don’t think that it’s necessarily part of this monopsony argument.

Luigi: No, I’m not saying that. I’m saying that the ability to restrict your mobility and your outside options has an impact in equilibrium on the wages that people receive. While it’s perfectly fine that if you are my employee, you cannot work for somebody else at the same time, if I hire you as an independent contractor, why do I have the right to restrict your outside activities as an independent contractor? It’s called independent for a reason. If you want to hire me as an employee, you take also the responsibility. If you don’t want to hire me as an employee, you should give me the freedom to do what I want in the rest of my time.

Kate: I think that this is a good segue into a different type of agreement that limits competition in the labor market. We’ve talked about no-poach agreements, which are issued by the firms themselves not to hire employees of other firms, or employees of other franchises. But there’s a different sort of agreement called a non-compete, which is on the part of the employee, him or herself. These type of agreement say that the employees are not supposed to use private information that they acquired as a result of working for a particular company, later on in their career, by working for another company. The purpose of this sort of agreement was to protect trade secrets, but now they’re basically ubiquitous in all sorts of contracts, including in high-tech firms.

Luigi: Let’s be clear, there are potential efficiencies in consideration for non-competes. As Kate said, it is a way to protect the trade secrets of a company, because there is a possibility of suing for stealing trade secrets, but the problem is, when you sue, you have to reveal the trade secret, and so this avenue is not particularly attractive for many high-tech firms. However, the non-competes are diffuse also among known high-tech firms. They do restrict the mobility of workers, so much so that for example, in the state of California, those non-compete clauses are considered non-enforceable. If you’re working in Silicon Valley, you can move from one firm to another without risk of being sued. In fact, the company will try to sue you anyway, but if you fight in court, you’re going to win.

Kate: So one thing that interacts very closely with this issue of employer market power is how much employees can actually move around. If you’re free to move around wherever, then it’s easier for you to find a job somewhere else. To this point, non-competes restrict labor mobility. If you have signed a non-compete agreement with your current employer, and you then want to move to a higher-paying job at a similar employer, then you may decide not to do that, because you’re afraid of violating your non-compete agreement and getting sued by your old employer. So to the extent that non-compete agreements interfere with the labor mobility and restrict labor mobility, then they’re making this monopsony problem worse, in the sense that they could be depressing wages.

Luigi: While only, only maybe is not the right word, but 20 percent of the labor force today is covered by a non-compete agreement, the impact of these non-compete agreements can spill over to other employees. The fact that Kate is not willing to move to my firm because of a non-compete agreement makes workers in Kate’s firm have lower wages. This might impact also other wages outside, because people look at what is the prevailing wage, and the prevailing wage is lower, and so they end up offering less to other workers as well. So this spillover effect can be quite important in explaining why wages aren’t rising fast enough, even in a moment of a high demand for labor.

Kate: I think one thing that we can do more to address this issue, is to support the people who are taking risks in their lives and their careers to actually file these class-action lawsuits. For example, if you decide that you want to sue McDonald’s for having these non-poach agreements amongst all their franchises, you were probably a McDonald’s worker before that. You probably are struggling to support yourself and your family. It’s incredibly costly to go through years and years of litigation, to try and fight these sorts of agreements. Even if it’s on behalf of a bunch of people, and even if there’s a chance that you’re going to get some money at the end. Even though lawyers tend to do this sort of work pro bono, or they get funding from other sources, I think that we should band together and create pools of funds, to support people who are willing to go after companies in these ways, so that they can earn a decent wage while they’re battling through these lawsuits.

Luigi: Kate, I think we should all support you for starting a class-action suit against business schools, for colluding in keeping your wages low.

Kate: Whoa, whoa, whoa, the University of Chicago is the one with all the cash sitting around. Why don’t we do this at Chicago?

Luigi: I’m not an assistant professor. You said that we should support the people who are hurt by these collusive agreements, so I argue that you are hurt. You are the first one who should start this class-action suit, and I will support you.

Kate: OK, thanks. I’ll think about it.