As a followup to my review of Chrystia Freeland’s good book Plutocrats, and in honor of Forbes’ release of their latest list of the World’s 1,426 Billionaires, everybody should watch this video. Do it, it just takes 6 minutes. We can’t have a useful dialogue about these things if we don’t have the facts.
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Chrystia Freeland takes on this topic directly with her useful analysis in Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else
Freeland’s proximity to plutocrats as a business journalist for the Financial Times and more recently at Thompson Reuters – she works among them but is not of them – allows her to be close enough to recognize their humanity and real strengths, but also to critique them – and the global forces at work that led to their rise.
The Rise of the Plutocrats
Freeland uses anecdotes, academic research, and data to explore the causes and consequences of the rise of an ultra-rich global cohort. An early 21st Century phenomenon, they command the most impressive concentration of wealth at the top[2] of their respective societies since the late 19th Century Gilded Age in America.
Freeland does not concentrate on the so-called 1%, not even the top 0.1%. The plutocrats of her focus occupy an even higher Olympian perch of wealth than that.[3]
She describes how the plutocrats as a group are the “working rich,” often earning their wealth in their lifetime and typically continuing to work extraordinarily hard long after they’ve “made it,” far beyond any material requirements in their own lifetime.
Driven by ideals and ideas
The plutocrats in Freeland’s description – especially in the US – are people of ideas and ideals, motivated not by avarice but by the thrill of the big idea or the key innovation. Their status derives from philanthropy or from attending TED Talks, The World Economic Forum at Davos, or the Council on Foreign relations, more than it derives from the traditional accumulation and display of yachts, castles, and polo teams.[4]
Freeland points to two powerful forces which have facilitated the rise of the new plutocrat class. First, in what she labels the “Marshall Effect,”[5] a widespread increase in societal wealth often leads to an even great concentration of wealth among top performers. Increased wealth outside of the traditionally richer Western World, for example, has benefitted not only newly developing countries but the capitalists of the older developed countries as well.
Second, in what Freeland labels the “Rosen Effect,”[6] certain newer technologies have allowed for scale-ability in markets and therefore even greater outsized compensation for superstars. The very top performers in a given area can access a ‘personal market scale’ previously unimaginable in earlier eras.
These twin effects strike me as accurate explanations for the rise of global plutocrats, and Freeland provides myriad anecdotes from her research to flesh out the role of globalization and technology in the creation of a plutocrat class.
Freeland usefully describes the new billionaires of fast-changing Russia, China, India, and Mexico as well. Their rise, in Freeland’s telling, owes relatively more to ‘rent-seeking’ behavior than to the idea-driven technological breakthroughs of Silicon Valley. ‘Rent-seeking’ is economist-speak for capturing underserved economic advantages through non-productive and illegitimate activities such as bribing government officials or the indirect capture of regulatory bodies to achieve profitable, private monopolies.
The Russian Oligarchs
Freeland’s prose strengthens when she describes the rise of the Russian oligarchs over the last 20 years, previously profiled in her book Sale of the Century: The Inside Story of the Second Russian Revolution. The similarities and differences between Russia’s plutocrats and plutocrats in, say, the United States bear exploring.
The Russian oligarchs represent a clear example of extraordinary wealth acquired by a tiny number of men through illegitimate means during the chaotic privatization of the 1990s. Whatever the oligarchs come to represent for Russians in the future, for now, at least, they indelibly stamp Russian-style capitalism as fundamentally unfair. Non-plutocratic Russians can’t help but feel the game to acquire wealth has been fundamentally rigged against the meritocratic, but unconnected, capitalist.
Later, Freeland describes quickly but convincingly how China’s financial elites owe much to their close ties to the ruling political elite,[7] the way India’s plutocrats engage in outright bribery with regularity, and why Mexico’s Carlos Slim – the world’s richest man – is the capitalist Mozart of rent-seeking behavior.
The US traditionally celebrates its plutocrats
Traditional US society has long legitimized and celebrated its plutocrats, from JP Morgan a century ago to Bill Gates over the past twenty years. Even if we could not all create the next ‘killer app,’ mainstream Americans embraced the myth that almost anyone could, with enough pluck and luck, be the next Mark Zuckerberg.
More than any other culture in the modern age, US citizens traditionally believe that the game is not fundamentally rigged against the merely meritocratic, but unconnected capitalist. Market-oriented capitalism, for all its failings, seems legitimate, to most people.
In the post-Great Recession environment of the United States, characterized by the Occupy Wall Street movement and a newfound distrust of the means of wealth acquisition among the 1% and above, however, I think Americans need to discuss the extent to which society in the United States continues to believe in the system’s legitimacy.
By anthropologically cataloguing the habits and habitats of Russia’s oligarchs, China’s new billionaires, and the US’s tycoons, Freeland suggests the question of legitimacy.
Not a conspiracy in the US, but cognitive capture
In the final two chapters Freeland offers a nuanced description of the way in which the US system, at least with respect to financial regulation, is rigged in favor of the very top.
While financial elites do not typically engage in outright bribery or transfer of wealth from public to private hands in the US, they don’t need to go that far to tilt the rules in their favor.
“Cognitive” or “systemic” capture – the way in which elites in government or regulatory roles adopted the Wall Street perspective as their own perspective – does the work in place of an outright conspiracy.
As Freeland writes:
“[T]he real story isn’t one of individual corruption. It is…about systemic capture. The vampire squid theory of the super-elite is entertaining and emotionally satisfying. It can be fun to imagine the super-elites who went to Wall Street and their Harvard classmates who became economics professors and those who became US senators participating in a grand conspiracy (hatched ideally, at the Porcellian Club) to rip off the middle class. But the impact of these networks is much less cynical, and much more subtle, though not necessarily of less consequence.”
During the 2008 Credit Crisis, the fact that then-Treasury Secretary Henry Paulson grew up professionally at Goldman Sachs, and personally knew very well all the heads of Wall Street firms as colleagues and competitors, drove the Wall Street-friendly bailouts.
You don’t need to be a conspiracy theorist, or even a believer in any outright corruption, to acknowledge that Paulson’s world view – that what was bad for Wall Street would be bad for Main Street – drove his very-few-strings-attached-just-save-them-at-all-costs generosity to the Too-Big-To-Fail Banks.
I think Freeland’s nuanced explanation of “cognitive capture” explanation goes a long way to explain the 2008 Credit Crisis and our inability to rein in the TBTF banks better than any conspiracy theory.
Some quibbles about the book
Chrystia Freeland’s Plutocrats toggles between several modes of business-writing, not all of which successfully interact.
Less usefully, but perhaps inevitably, Plutocrats offers up tidbits of voyeuristic gossip, as Freeland name-drops her elbow-rubbing and panel-facilitation with the ultra-rich in places such as Davos, Sun Valley, and Aspen. I cringed a little at reading some of this, but then again, what was I expecting? I suppose we all need to compare the contradictory clichés of “Stars! They’re just like us,” versus “The rich really are different from you and me.”
Worse, Plutocrats sometimes reads as a traditional, business-school-style “How to,” book, offering anecdotes and bromides from current plutocrats for aspiring plutocrats to emulate. We learn in Chapter 4, “Responding to Revolution” that emerging markets offer opportunities for faster growth than the traditional Western ‘developed’ countries. Further, successful wealthy entrepreneurs excel at exploiting opportunities, and the ability to guide their startups through a crucial business-direction “pivot.”
Groan.
A missing explanation for the rise of Plutocrats in the United States
Freeland leaves out an exploration of how changes in the tax code in the United States in the last 30 years – especially with respect to top marginal income tax rates, dividend taxes, capital gains taxes, carried interest taxes, and inheritance taxes – institutionally spur income and wealth inequality, especially at the 1%, level, 0.1% level, and above.[8]
Wealth at the highest level inevitably is wealth derived from equity ownership; that is to say, derived from business earnings rather than salaries. When Congress dramatically lowers top marginal income, dividend, capital gains and inheritance taxes – as has happened in the US in comparison to 1980 – it increases personal incentives for highly unequal compensation.[9]
Reasonable people, from different places on the political and economic theory spectrum, could debate the relative merits of this trend in tax policy, but I think its absence from Freeland’s discussion of the rise of massive wealth and income disparities, at least in the US, weakens her explanation.
Please see related post: All Bankers Anonymous Book Reviews in one place.
[1] I’m still working out what the other Bankers Anonymous topics should be. So far, in addition to massive income and wealth concentration at the top, I think they are: What to do about Too-Big-To-Fail banks in the US; What should every adult citizen understand about personal finance; What are the consequences of the finance industry attracting such a high proportion of elite talent (rather than technology, education, medicine, engineering, social services, etc); How not to invest; Is poverty in the US an inevitable consequence of relatively free markets, or a failure of societal empathy; and What the hell really happened in 2008? That’s what I have so far. I’m open to further suggestions from readers to round out my top 10.
[2] Freeland describes different layers of the plutocratic stratosphere, at times changing levels without prior notice. Mostly she means to describe the extraordinarily wealthy, although she never defines her ‘cut-off’ level to qualify as a plutocrat. She cites the existence in 2011 of 84,700 Ultra High New Worth Individuals (UHNWI, as coined by Credit Suisse Bank), in the world – defined as owning $50 million in assets. One can infer from her descriptions that she means to start somewhere near the low-end of “Mitt Romney wealthy” of say, an estimated $200 million, and go up from there. At times in Plutocrats, however, she downshifts to describe the habits and rise of the merely wealthy, entrepreneurs or Wall Street employees in the $50-100 million net worth range.
[3] Freeland makes the important point to distinguish gradations within the so-called 1%. According to Freeland, the top 1% of earners in 2007 reported an average income of $486,395. These, most decidedly, are not plutocrats. Further up the mountain, there were 134,888 taxpayers in the top 0.1% in the United States in 2007. Still too many. The US has 35,400 UHNWI, boasting $50 million or more in assets. Getting warmer. A smaller number, 15,000 Americans, reported average annual incomes of $23.8 million, constituting the top 0.01%. Only 412 US citizens were billionaires in 2007. The number of plutocrats seems to be somewhere between 500 and 15,000 in the US.
[4] The three plutocrats I’ve known in my own life, each from the United States, all fit Freeland’s type. They worked extraordinarily hard at creating wealth in their own lifetime. Equally striking, they dedicate extraordinary passion and energy toward their educational and medical philanthropies respectively. They are curious, generous, and personally modest in affect.
[5] 19th Century economist Alfred Marshall noted that while the 1st Industrial Revolution led to a rise of incomes broadly, certain individuals reaped outsized returns from the rising tide.
[6] 20th Century economist Sherwin Rosen pointed to technological gains to explain the concentrated success of superstars in a modern economy.
[7] One side note on China that I found (gruesomely) fascinating: Freeland cites an article that Chinese authorities executed 14 billionaires between 2003 and 2011, presumably on corruption charges. I cannot even fathom the kind of changes that would have to come about in US society to see 14 billionaires executed on corruption charges. In a related story, apparently Chinese billionaires keep a much lower public profile than their counterparts in Russia, India, Mexico, or the United States.
[8] Since you asked, here’s some more of my views on the tax code’s favoritism for those at the top.
[9] Which is why a guy like Sheldon Adelson should give even more money to the GOP.
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I concur about the causes and problems of persistent and rising inequality in the United States, and I suspect Stiglitz and I would vote for similar political candidates. But my goodness, this is a painful book to read.[1]
First, Stiglitz writes lazily about banking, making errors and relying on simplistic generalizations to match his political points. As an ex-banker, I’ve got a little problem with Nobel-Prize winning economists getting basic facts wrong about banks in this country.
Second, Stiglitz never surprised me – not with his descriptions, his anecdotes, nor the economic studies he cited. Instead, any consistent reader of the New York Times and Wall Street Journal will know, in advance, the arguments and examples he cites.[2]
Finally and worst of all, Stiglitz is a hammerer, not a sifter, of ideas. He pounds away at the inequality problem, always from the same left-of-center perspective, until all current events have been beaten into the same shape.
A bit more sifting, or a weighing of alternative perspectives would have won me over to his side.
No, that’s not exactly right. I started out on his side. A bit more sifting of competing thoughts would have prevented me from wanting to jump to the opposite side and point out all the ways he simplifies and distorts the left-of-center perspective. I read a hammer book like The Price of Inequality and I just want to throw the hammer away.
If the last book I reviewed Unintended Consequences has one set of opening assumptions – that growth is the most important goal of economic policy and that financial incentives are a key to growth – then The Price of Inequality takes the opposite view of economic policy based on a very different set of starting assumptions.
While Unintended Consequences built a measure of good will with me, as a reader with banking experience, The Price of Inequality quickly gets my hackles up with a series of incorrect statements about banks.
MF Global did not, as Stiglitz incorrectly states on page 36, falter primarily as a result of derivatives trades – but rather it declared bankruptcy after a series of overly aggressive bets taken by its head Jon Corzine. Corzine thought European bonds were cheap, so he loaded up his firm’s balance sheet with them, in the hopes that European bond prices would recover. He was wrong, and the firm went under. Derivatives were irrelevant.
There are not, as Stiglitz incorrectly states on p. 46, “hundreds of banks,” in the United States. In fact there are over 7,000 banks in the country.
More troubling than these factual mistakes, however, is Stiglitz’ oversimplification in describing bank misdeeds. For example, banks did not, as stated on page 47, systematically rig LIBOR ‘enabling them to make still more profits.’ The LIBOR rigging, perpetrated by a small number of cheating traders, had an unknown effect on profitability of the banks overall, and a reasonable argument could be made that systematically lowering LIBOR actually hurt banks’ overall profitability, as their lending portfolios would suffer from the lower interest rates sought by the riggers. The rigging was wrong, and the cheaters will be and are being punished, but Stiglitz’ simplification doesn’t help his credibility.
Most egregiously, Stiglitz perpetuates the view, mistaken in my opinion, that predatory mortgage lending constituted a predominant bank strategy in the years leading up to the Credit Crunch. Stiglitz describes the ‘rent seeking’ behavior of mortgage banks exploiting the poor through predatory lending, which he claims brought the banks extraordinary profits.
Ah, where to begin on that one? Perhaps with those “extraordinary profits?” Did anyone else notice the extraordinary losses banks took due to lending to poor people? The write-downs and bailouts of 2008 and 2009 were a direct result of losing money, not making money, on the sub-prime debacle.
And then, if predatory lending was such a winning strategy, why aren’t banks falling all over themselves now to lend to the poor? There are certainly more poor, and more unemployed now than there were during the boom years. It should be a real boom time to pile up all those banking profits lending to the poor – right now, no?
What, you say, banks aren’t lending to poor people now? Why do you think that is Mr. Stiglitz?
The real answer, the logical answer, is that lending to the poor is generally a terrible banking idea, and that banks don’t do it in the ordinary course of business. The lending that led to the Credit Crunch was a short-lived, devastating experiment. A near-death-experience-type experiment for banks.[3]
Look, lending to poor people is a damned-if-you-do, damned-if-you-don’t situation for bankers. For the past thousand years, traditional banks did not do it because it’s not profitable. To make up for that lack of profitability, federal government policies[4] demand some measure of lending to disadvantaged neighborhoods, while Fannie Mae, Freddie Mac, FHA/VA and USDA (among others) each in their own way incentivize mortgage lending to poor households.
For a brief decade – 1998 to 2007 – banks responded to a combination of government and market incentives, and the sub-prime market boomed. They did it from 1998 to 2007 based on a misunderstanding of market incentives, primarily rising real estate values and history-naïve modeling.
Sub-prime mortgages – before they became a bad word – were praised as an ingenious way of expanding home-ownership, of inviting more Americans into the American Dream. Stiglitz’ narrative of the banker as profit-making predator and the poor homeowner as naïve victim – while common – is a distorted myth that ignores history and reality.[5]
Why do I get so agitated over Stiglitz’ simplification? Just this: If we completely mischaracterize the financial debacle of 2008, we’re likely to learn all the wrong lessons from the Crisis. I realize its politically appealing to blame the greedy bankers and absolve the plucky poor people exploited by the greedy bankers. I’m a creature of the same culture as Stiglitz and I love to criticize bankers too. But please can we agree not to lie to ourselves so much about the mortgage debacle?
Ok, now back to the other problems with Stiglitz’ book.
If I assume I’m a pretty good representative of the intended audience for The Price of Inequality – Non-academic, informed on current events, politically opinionated, concerned with inequality – then why is this book such a chore to read? I think it has something to do with the fact that Stiglitz’ examples all come from the same headlines and articles I’ve already read in recent years.[6] I kept waiting for the original idea or surprising, counter-intuitive insight, but I waited in vain.
He offers statistics on the terrible state of wealth disparity in the United States, but in the driest way possible.
In the final analysis, I expected a more thoughtful weighing of evidence and ideas. Stiglitz’ book wades into an important ‘Battle of Big Ideas,’ but he has no taste for engaging the opposition on its own terms. He’s a warrior for his own side who does not speak the language of his enemy and cannot conceive of their humanity.
When someone wins the Nobel Prize in Economics, does that confer a monopoly on all the good ideas about a complicated topic like socio-economic inequality? Are there, possibly, unintended consequences[7] to his policy prescriptions? Does the opposition deserve a careful and open hearing?
Stiglitz really knows how to put the dismal back into the dismal science. For a more intuitive, specific, sometimes funny, and interesting read on inequality and its societal costs, can I interest you in an excellent book here?
Please see related post: All Bankers Anonymous Book Reviews in one place.
[1] This is the opposite of my reaction to Ed Conard’s Unintended Consequences, which I reviewed earlier in the month, and which forms a neat book-end as the opposite worldview to Stiglitz’ The Price of Inequality. Even though I disagree with many of Conard’s proposals, I enjoyed reading the book and would recommend it. I guess I’m a contrarian that way.
[2] The New York Times’ Thomas Friedman is guiltier of this than anyone. Never read his books. I picked up The World is Flat only to discover that he’d retreaded his and his colleague’s columns and observations from the previous 5 years. If you read newspapers regularly, you don’t need one of his books. Did you know that hedge funds are allocating capital quickly around the world? Did you know globalization is having far-reaching effects, visible even in small villages in foreign countries? Wow. Give that guy another $45,000 speaking fee.
[3] I recommend this clearly written research paper by the Cleveland Federal Reserve about subprime lending myths.
[4] Primarily via the Community Reinvestment Act, known as the CRA.
[5] An interesting time-capsule on sub-prime lending comes from The Federal Reserve Bank of St. Louis in January 2006, characterizing the risks and rewards of the booming sub-prime mortgage market. The research article has the advantage of not being tainted by the moral outrage that followed every subsequent discussion of sub-prime lending after 2008. Accurately enough, the article states “subprime lending is simultaneously viewed as having great promise and great peril.”
[6] One example of rehashing known headlines and anecdotes: He cites on p. 163 the infamous (and possibly apocryphal) Tea Partier whose protest sign read “Govt hands off my Medicare.” Nevermind the silliness of citing one foolish protester to make a point, the recycling of Jon Stewart zingers does not win him any originality points.
[7] See what I did there?
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As soon as Edward Conard hit the book-selling circuit with Unintended Consequences: Why Everything You’ve Been Told About the Economy Is Wrong
“You have got to review this book and tear this guy apart,” my friends urged, and I promised I would.
Suspecting I would not want to own the book, I put in a request to borrow it from my local library, only to endure 2 months on the waiting list before a copy became available. Meanwhile Unintended Consequences hit the New York Times best seller list and Conard went on to represent the Bain Capital perspective all up and down the cable television circuit. Unintended Consequences finally became available at the library at the end of the summer, and I read it over Labor Day weekend.
My dear liberal friends, I have a confession to make: I like this book quite a bit.
I’m not saying you need to go out and buy it, as I’m sure you will not. But I am saying the guy has made a serious and effective effort to represent the Mitt Romney view of the world, one which has an internally consistent logic, if you agree with his assumptions.
Let me start by describing the part of the book I really liked, followed by the part I liked pretty well, and then I can finish with a critical flourish that I expect will return me to the good graces of my liberal friends who recommended I review it in the first place.
Conard organizes the book in three sections, “What Went Right,” “What Went Wrong,” and “What Comes Next,” sections which may otherwise be described as Past (1950-2005) Present (2006-2012) and Future (beyond 2012). In summarizing my views of the book: I loved the Present; I liked the Past; and I plan to get a little snarky in the Future.
“What Went Wrong” – The Mortgage Crisis
I’ve invested a significant portion of my working life in the mortgage finance industry, first as a mortgage bond salesman, then as a hedge fund investor purchasing consumer debt including mortgages, and most recently as a self-appointed commentator – blogger – on the Credit Crisis and Great Recession trying to figure out causes and effects that stem from the mortgage market blowup.
As a result of my professional past, I cannot state strongly enough how much it bugs me to read terrible analysis from otherwise respectable journalism sources about what went wrong with the sub-prime mortgage market and the Credit Crunch.
If most journalists get the mortgage story 50% right and 50% wrong, Edward Conard gets it about 90% right, and for that fact alone I am grateful for his book. In debunking a significant portion of the equine urine that passes for our national sub-prime mortgage narrative, Conard earns my gratitude.
Forthwith, some mortgage market narrative myths Conard helps debunk:
Predatory bankers frequently tricked people into taking out loans that they could not afford to pay back. Um, no. This is not a real world banker strategy, to lend money to people who cannot afford to pay back the loans. It’s just not. It’s illogical to believe most bankers seek to make bad loans, and it drives me nuts to read this implied or stated by otherwise intelligent writers. Bankers in the real world make loans to people they believe will pay them back. In the run-up to the most recent crisis, Wall Street mortgage bond structuring departments and mortgage investors mistakenly believed rising home values and low interest rates would help sub-prime borrowers refinance before they defaulted 1 – a pattern that only worked for a short while – but it was a mistake, not a conscious predatory strategy. 2
On the other hand, I have dealt in my investing business with many predatory borrowers, people who took out mortgages they knew they could never pay back, but who hoped to get lucky with real estate price appreciation or who hoped to delay the foreclosure process long enough to keep a house for free while they defaulted on their debt obligations. That scenario happened to me in my investing business almost too many times to count, but I never once met a banker who sought to make a loan that couldn’t be paid back. It’s bad for business. Banks that make loans that can’t be paid back go out of business quickly.
2. Wall Street Banks, in a conspiracy with the rating agencies, duped mortgage bond investors in the run-up to the crisis. Not even close. While it is true – and Conard acknowledges as much – that there’s an imbedded conflict of interest in the fact that rating agencies get paid by Wall Street to rate their products, its equally true that mortgage bond investors are among the most sophisticated financial analysts found anywhere. They were, and are, hyper-aware of exactly who pays whom. Mortgage investors know what massive grains of salt need to be applied to rating agency information. Just because journalists and politicians recently discovered the role ratings agencies play in the investment world does not mean mortgage investors needed them to discover that role for them. It’s a known Wall Street truism, which I stated before and will state again as long as I need to: Professional investors never react to rating agencies moves,3 and professional investors understand the limitations of bond market ratings.
3. CDOs and other mortgage derivatives became so complicated that they were bound to blow Wall Street up. A common journalistic conceit in describing bank losses due to CDOs 4 and the alphabet soup of other mortgage bond structures (RMBS, ABS, CMOs, CMBS, IOs, and POs to name a few of the more common ones) implies that the opaque nature of structured products doomed them to failure. Not true. Just because a journalist does not understand the product does not mean that the structurer, trader, and mortgage investor do not understand the product. The mortgage bond desks of Wall Street firms and of bond buyers make it their job to understand their products.
Some mortgage derivatives, CDOs in particular, suffer from a chronic lack of liquidity, for which in ordinary times the market demands compensation, in the form of higher yields. In the Credit Crunch of 2008, CDOs and other structured products became untradeable at anything like fair market value. They are terribly illiquid, not terribly complicated, for professionals who traffic in structured mortgage products.
In addition to effectively debunking some myths of the causes of the Credit Crunch, Conard gets the story right in a few other respects, namely:
In sum, Conard builds up a lot of good will with me by getting the causes of the Credit Crisis essentially correct, or at least far more correct than I’ve read in other books and journalistic narratives.
“What Went Right” – The US Economy, 1950-2005
In this section we begin to see daylight between Conard and me, although not because he’s necessarily wrong, but rather because we have different starting assumptions.
Conard became such a target for liberals with the publication of Unintended Consequences for his unabashed celebration of massive wealth concentration for successful business people. He sees inequality as a natural consequence of a difference in people’s work ethic, their innovative contribution to economic progress, and what he terms ‘lucky risk taking,’ by the entrepreneurial and investor classes. As a Bain Capital partner, he and his book represent to liberals the ultimate voodoo doll for Romney-bashing in an election year. We’ve seen enough of Romney’s comments on and off the record to believe that there’s considerable agreement between Conard and Romney on this view.
I have issues with the Conard/Romney world view, but I want to be careful to point out what I like about Conard’s argument. His ultimate concern, clearly stated, is growing the total amount of economic output in the most efficient way possible. He believes that incentivizing people and institutions to maximize economic output – via financial gain – is more effective than anything else at producing a growing economy. Impediments to economic growth, in the Conard universe, include taxes, business regulations, trade restrictions, and income redistribution payments, each of which he believes lead to lower economic output over time.
Now, while Conard does not prove his assumptions to be true, they all strike me as logically correct. I too believe that each of those factors leads to lower economic growth.
Where we differ, and where I expect my liberal friends will gather around me again in support, is whether maximizing raw output in an economy is the single most important goal. I happen to believe that inequality of income and wealth outcomes have quite a bit to do with whether an economy is ‘successful,’ and have quite a bit to do, as well, with whether my society is the best it can be. At a certain point, I would trade some GDP growth for a bit more justice in the world, and I might choose a societal safety net now at the expense of a marginal innovation in computer processing.
Conard consistently advocates the economic growth path over the economic justice path. Before I paint him in overly simple terms, however, I think it’s worth returning to the Conard argument on its own merits, to appreciate it for what it is.
I find his argument entirely credible, for example, that our choice of wealth distribution via transfer payments dooms us to a lower growth path as an economy as a whole. I believe him when he argues that taxing the wealthy, who allocate an average of 40% of their income to economically productive investments, will leave less capital available for innovation, production, and economic growth. I agree with him when he states that in a global economy of efficient markets the unionization of US workers will quickly lead to offshoring of those jobs on the one hand, and higher consumer prices on the other.
One Conard argument about the success of the US economy in recent years stands out when compared to Europe and Japan. He notes that in the last two decades of innovation in computers, software, the internet, and social media, the United States essentially ‘ran the table’ when it came to all of the most important businesses. Citing “Google, Facebook, Microsoft, Intel, Apple, Cisco, Twitter, Amazon, eBay, YouTube and others,” he highlights the US economy’s investment climate and rewards for risky innovation as a differentiating factor compared to the rest of the developed world.
In sum: I believe Conard when he argues for the factors that lead to higher growth of an economy overall. I don’t want to live in that society, but I do think it’s useful for people who disagree with the Bain Capital model to think about what they’re willing to give up to live in a different type of society. Are you willing to be a little bit poorer?
What Comes Next – Conard’s Future
In the third part of Unintended Consequences I have to part ways with Conard entirely. I can’t endorse his prescriptions for the economy, in part because I don’t agree with his view of growth vs. equality, but also because he begins to reveal a curious coldness that hurts his arguments.
In the wake of the Credit Crunch, Conard argues not for regulating banks more but rather for enduring bank runs like we experienced in 2008 since “The Crisis also reveals that the cost of government guarantees, excluding the future cost of moral hazard, was near-zero. In fact, the government expects to turn a profit on the assets it bought to mitigate withdrawals in the Crisis.” Notably absent is his reckoning of the cost in human terms or non-government costs of the financial wipeout for so many.
Conard also displays a curious tick in his thinking – and his writing – of quickly taking any government imposed limitation (taxes, regulations, unionization, trade restrictions) on individual or corporate wealth and translating that immediately into “even more lost jobs and higher consumer prices.” As I review his book, he appears to do this every single time. Anything that affects the rich and upper classes, in Conard’s description, has an opposite and larger detrimental effect on the middle and lower classes. The first few times he does this I’ll acknowledge that, yes, some government interventions may have unintended consequences in other areas. But when Conard continues to say it every single time I’m left thinking – ok, I get it, higher taxes on your Bain Capital folks is just going to bite the rest of us even worse every single time, in all cases. Unfortunately, by applying the same response to different situations his opinions appear less evidence-based and more economic dogma-based.
My final thought about Unintended Consequences is that’s it’s curiously devoid of any personal or professional anecdote. Conard worked for Bain Consulting, Wasserstein Perella, and then finished his career as a partner of Bain Capital, running its New York office. Surely Conard accumulated not only material wealth, but a wealth of interesting business stories with which to illustrate his logical, yet dry, economic analysis? But Edward Conard, the person, is curiously absent.5 So where are the people in Unintended Consequences? Ultimately Conard’s book describes a mechanized world of efficient human economic units, each maximizing their own utility for private gain.
What does Conard think of people who don’t fit this dry, efficient world? In his own words: “A shortage of talent exists, in part, because a large number of college graduates refuse to take the risk and responsibility necessary to bring unrealized investment opportunities to fruition. Art history and Elizabethan poetry don’t employ workers; the arduous and tedious application of business sciences such as computer programming and accounting does.”
Ok, then.
If you would like a country with higher economic output and more wealth for some people, “Vote Romney/Ryan 2012!”
However, if you would like a world with a bit more poetry in it – and a measure of social justice – you may want the other guys.
Please see related post:
Book Review: The Upside of Inequality by Edward Conard
All Bankers Anonymous Book Reviews in one place.
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Barbara Ehrenreich engaged in stunt journalism in order to write Nickel and Dimed: On (Not) Getting By in America. She temporarily shed her middle class, educated life in order to understand the working poor. Over the course of six months, she worked minimum wage jobs and tried to pay for shelter, groceries and other expenses on only her monthly take home pay – an impossible task for her.
She apologizes upfront for the stunt by acknowledging the artificial short-term nature of the experiment as well as her advantages over the typical working poor in the United States. She is white, native English-speaking, highly educated, in excellent health, and very motivated. And yet the challenges she faces in paying for basic food and shelter would – if we are honest with ourselves – break most of us down.
Ehrenreich works for $2.43 an hour – plus tips – at her first job in Key West, FL at a hotel restaurant. Next she moves to Portland, ME to juggle a maid job at $6.65 per hour with a similar low-paying job in a nursing home. Later she works in the ladies clothing department at a Minneapolis Wal-Mart. Typically, a single job leaves her short on rent and food money at the end of the month, although she lives in low-rent places such as a cramped, out-of-the-way cabin, a weekly-rate hotel, and a dingy, off-season trailer park. Juggling two jobs, a theoretical solution, leaves her exhausted and physically unable to perform the first job. It never quite works, and there’s seemingly no way to get ahead for the working poor.
Ehrenreich’s prose is funny[1] enough to lighten the burden she feels at the indignities of pee-testing, preposterous middle management patronizing, personality testing, and polyester uniforms. She illustrates in specific ways[2] how the poor live in a parallel universe from you and me, even though they are stocking shelves or pouring coffee right next to us.
Ehrenreich’s writes about her experience during a boom time in America – 1998 – when unemployment reached a record low and corporate America complained about a dearth of workers. This makes her narrative all the more compelling today, as in even the best of times the working poor have little chance to afford basic material necessities.
Although I read the book years ago when I worked on Wall Street, during the past few years of the Great Recession I’ve thought frequently about Nickel and Dimed. We often hear a television commentator or political leader speak ruefully about the “middle class jobs lost,” as if that’s the national tragedy.[3]
It really gets up my nose, however, that we find tragedy in “educated, middle class people being out of work,” but we don’t focus on the persistent national tragedy of people who have been in recession all along. Yes, the Great Recession threw a high number of white collar folks out of a job. But the GR narrative stresses ‘white color’ jobs, by which I mean the image of ordinarily highly employable people suddenly struggling, rather than the large number of long-term working poor or under-employed people.
I really do not mean to sound indifferent about the tens of thousands of wonderful finance jobs lost in the Great Recession, or the millions of middle class folks who have struggled in recent years, but I do find the obsession with the middle class, rather than the working poor – the true underclasses in the United States – a curious omission in our American economic narrative.
The national unemployment rate rose from a low of 4.5% in 2007 just prior to the Great Recession to a current rate (in mid-2012) of 8.2%. The African-American unemployment rate meanwhile has remained high at 8.3% and 14.4% respectively, nearly twice the national rate in 2007 and in 2012.
Are the 30% of Americans in a persistent state of underemployment, unemployment, and poverty invisible? Yes, they are. In this Great Recession, we just ignore them, because their situation is assumed to be unchangeable.
Both political parties shy away from acknowledging the working poor or people in chronic poverty. It seems only the “middle class jobs lost” are worth lamenting.
From the Obama “Jobs and Economy” page: “For years before the economic crisis, middle-class security had been slipping away. Wages stagnated while health care costs soared.”
From the Romney “Jobs and Economic Growth” page, we get a helpful “Middle-Class Promise Gap: Unemployment“ [LINK has been taken down with the end of the campaign.]
You will not find either candidate for President discussing the working poor or the persistent underclass in the United States. I guess the working poor and unemployed don’t vote in sufficient numbers? They certainly don’t donate enough to campaigns to matter.
The cone of silence increasingly ignores the American reality of wealth stratification.[4]
I currently live in the one of the poorest large cities in the United States, an urban environment with persistent poverty rates around 25% of the population. For children under age 10, closer to 30% are growing up in households below the poverty line with a similar rate of undernourishment. Their poverty was real before the Great Recession, it is real now, and because few leaders seem concerned about the issue, it will be true for the whole next generation to come.
In my hedge fund business, I invested extensively in municipal tax liens[5] in upstate New York. Many upstate New York cities barely noticed the Great Recession. Instead, decades prior to the recession, the regional Rustbelt deindustrialization kept them in a depression characterized by high rates of poverty, declining population, and falling real estate values.[6]
A permanent recession in some regions and in some population groups is the real story. Nickel & Dimed is the real story.
My guess is anybody who reads this book review lives well ensconced in the middle class or above, and spends little time thinking on a daily basis about the working poor or the nation’s chronic underclass. I’ll be the first to admit I certainly don’t. Instead, my day – like yours – is full of what may be called ex-banker problems, and of course, cat videos.
Ehrenreich’s Nickel & Dimed gave me insight into the way millions of my fellow citizens live. If more people should understand how high finance works, it’s even more essential that high finance folks understand how millions of their fellow citizens are getting by, or not, in America.
Please see related post: All Bankers Anonymous Book Reviews in one place.
[1] In writing this review I found myself struggling unsuccessfully to find something funny to say on the topic of the working poor and underclass in America. Her specific experiment had light moments, but humor kind of eludes me on this one.
[2] Multiple restaurant co-workers live out of their cars because they can’t afford the rent anyplace near their place of employment. Grocery shopping for healthy perishables proves impossible without a real refrigerator or kitchen. Working slowly can be rational when you’re paid by the hour. Neglecting antibiotics or doctor’s visits because of the cost can be devastating to your health and ability to work.
[3] It is certainly terrible to lose one’s job, and I do not mean to be callous about middle class folks who got laid off in the last few years. The great risk for a middle class person who joins the unemployment ranks is really falling into the huge underclass, at which point he will be effectively forgotten in the national narrative.
[5] As an investor, I purchased from municipalities a lien representing a senior claim on real estate for which the property owner had not paid City or County or School or Water taxes. After the expiration of a statutory period of time, my firm had the right to foreclose on the real estate. Many municipalities in upstate New York have a constant need to sell tax liens because of persistent tax delinquencies. That of course reflects the relative poverty and declining real estate values in the cities and towns of the region.
[6] For investors who would like to know just how depressed the situation is in some upstate New York cities, perhaps my real world example will provide a point of comparison. I sold a seven-unit residential building (acquired via tax lien foreclosure) in January 2011 for $75,000. While two of the units needed a little improvement, three of the units had renters, providing cash flow on the building. And I was happy to sell the building just to be rid of the risk. That upstate New York city is not coming back any time soon.
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