Business is a source of inequality—but in a good way—when innovators bring great progress in improved products and lower cost, even when they keep a portion of the gains for themselves. The masses of people benefit from cool technology, like smartphones, while also enjoying low prices by shopping at innovative stores. Sam Walton brought retail prices down across America, benefiting millions of consumers while getting extremely rich in the process. Inequality increased because of Walton’s wealth, but people were better off.
In my earlier article, Business Is One Reason For Economic Inequality—And Also For Equality, I made this argument without statistics. It turns out that new Nobel laureate William Nordhaus ran the numbers and found that innovators keep a very tiny fraction of the benefits they generate:
“I estimate that innovators are able to capture about 2.2 percent of the total social surplus from innovation.”
That result comes from two components. First, innovators only reap seven percent of the benefits in the first year of their innovation. (This is an average across all industries and time periods studied.) Think of a company that finds a cheaper way to make its product. It doesn’t just enjoy a higher profit margin; it also cuts its price to increase sales. Some of the gain in sales comes by undercutting high-cost competitors, and the price cuts also bring in customers who previously thought the product was too expensive. In both ways, consumers capture a large portion of the innovation’s benefits.
The second component of Nordhaus’s math is depreciation of the innovation’s value, which he estimates at 20% per year. Patents expire, trade secrets leak, competitors copy obvious innovations, and other innovators develop even better techniques.
The estimate that just 2.2 percent of total benefit is captured by innovators struck Nordhaus as surprisingly low, as it did me. But it shows how the great wealth of America’s innovators, such as Bezos, Gates, and Buffett, is small in comparison to the benefits of innovation that have accumulated over the years.
