The following is an excellent excerpt from the book “PLUTOCRATS: The Rise of the New Global Super-Rich and the Fall of Everyone Else” by Chrystia Freeland from Chapter Five: “Rent-Seeking” on page 218 and I quote: “Rent-Seeking on Wall Street and in the City – The regulatory race to the bottom between New York and London–and the plutocracy’s eager and misguided complicity in that contest–is an important cause of the 2008 financial crisis. But it is also a crucial episode n another story: the rise of the super-elite. Much of this story of the rise of the 1 percent, and especially of the 0.1 percent, is the story of the rise of finance. And less regulation, more complexity, and more risk are important reasons why finance has become a bigger part of so many developed Western economies, particularly the United States and the United Kingdom, and why financiers’ income has overtaken that of almost everyone else.
That connection with regulation, or its absence, is also why the rise of finance is partly a story about rent-seeking. The government bailouts of banks and bankers in 2008 enraged populists on both the right and the left–the super-elite got a rescue that was denied everyone else. But the link between the state and the financial super-class is much deeper than providing a trillion-dollar safety net. Like Carlos Slim’s Telmex, and the beneficiaries of Russia’s loans-for-shares privatization, the bankers on Wall Street, in the city of London, and in Frankfurt owe much of their wealth to helpful decisions by their regulators and legislators.
In Goldin and Katz’s Harvard-based study of the impact of gender on life choices, they learned a lot about the different life choices and life outcomes for men and women. To their surprise, though, the most gaping disparity they found had nothing to do with gender. It was, instead, the gap between the bankers and everyone else.
“The highest earnings by occupation are garnered by those in finance, for which the earnings premium relative to all other occupations is an astounding. . . 195 percent,” they concluded. In other words, Harvard-educated bankers make nearly twice as much as their classmates who choose different jobs.
The higher incomes in finance seemed to provoke an equally dramatic shift in the career choices of Harvard grads. Just 22 percent of the men in the class of 1970 took jobs in finance and management. Twenty years later, 38 percent of the men of the class of 1990 went into finance and management–more than the numbers who chose law and medicine combined. Women shifted their choices even more sharply. Just 12 percent of the women in the class of 1970 took jobs in finance and management. Two decades later the number had nearly doubled, up to 23 percent.
That marks a profound cultural transformation. A few years ago, I interviewed a longtime friend of Paul Volcker, the legendary chairman of the Fed. Both Volcker and this friend studied economics at Harvard. I asked the friend, an academic, why neither of the pair had gone to Wall Street. “That was a third-rate choice,” he told me. “When we were at Harvard, the most prestigious job was academia; next was government service. Only the weakest students went into finance. Things have certainly changed.”
What’s most striking about these numbers, and this cultural shift that has come with it, is the extent to which they suggest that the rise of the super-elite is largely the rise of finance.
Wilder studies of the 0.1 percent tell the same story. One of the most comprehensive analyses of who is in that top slice found that, in 2005, 18 percent of the plutocrats were in finance. As the Harvard data suggested, that number has grown sharply in recent decades, up from 11 percent in 1979. The only occupation that accounts for a bigger share of the income at the very top is the CEO class. Moreover, within the generally prospering community of the 0.1 percent, the incomes of bankers are growing the fastest of all.
The numbers in the UK, where the ascendancy of finance in the national economy has been even more pronounced, paint the same picture. A recent study found that 60 percent of the increased share in income of the top 10 percent went to bankers–meaning that nearly two-thirds of the enrichment of the earners at the top was driven by the City of London. As in the United States, the gains are skewed to the very tip of the pyramid: among the financiers who are part of Britain’s top 1 percent, the top 5 percent (or 0.05 percent of workers overall) take 23 percent of the total wages of that gilded slice of the population. The dominance of top dogs in finance is even stronger than that of the 0.05 percent in other jobs.
One reason the preeminence of the financiers within the global super-elite matters is that it highlights how crucial financial deregulation has been to the emergence of the plutocracy. That story has been told most convincingly in a historical study published in 2011 by economics Thomas Philippon and Ariell Reshef.
I first heard of the paper when a draft version of it was presented at the central bankers’ conference in Basel, a prestigious annual wonk fest for the world’s central bankers and the academic economists who are their intellectual groupies. Held just six months after the peak of the financial crisis, the 2009 Basel meeting was tenser and more focused on the problems of the present day than usual. On his way home for the meeting, a G7 central banker, who had worked on Wall Street before going into public service, e-mailed me a link to Figure 1 in the Philippon and Reshef paper, with a short comment: “This says it all.”
That U-shaped chart plots the evolution of wages and skills in finance over the course of the twentieth century. Here’s how the two economies describe their findings:
“From 1909 to 1933 the financial sector was a high-education, high-wage industry. The share of skilled workers was 17 percent points higher than the private sector; these workers were paid more than 50 percent more than in the rest of the private sector, on average. A dramatic shift occurred during the 1930s: the financial sector starts losing its high human capital and high-wage status. Most of the decline occurs by 1950, but continues slowly until 1980. By that time, the relative wage in the financial sector is approximately the same as in the rest of the economy. From 1980 onwards another dramatic shift occurs: the financial sector becomes a high-skill, high-wage industry again. In a striking reversal, its relative wage and skill intensity goes back almost exactly to their levels of the 1930s.”
Bankers were the backbone of the super-elite in the first part of the century; then, starting with the Great Depression, their incomes leveled off, continuing in that period between World War II and 1970 when banking was a stable, boring business, like a utility. Then, from 1980, finance got more complicated and income again soared, eventually reaching the level of 1933. What is especially interesting about this data, which Philippon and Reshef were the first to put together, is how closely it follows the rise, fall, and then rise again of income inequality in the United States. Philippon and Reshef find that the rise of finance accounts for 26 percent of the increase in the gap between the top 10 percent and everyone else over the past four decades. This is partly because finance became a magnet for highly educated Americans.
The second important piece of the puzzle is figuring out why the behavior of bankers followed this U-shape. Why was banking far less popular and prestigious than law and medicine for the Harvard men of 1970, while the class of 1990 flocked to Wall Street? The economists measure the impact of various changes, including globalization, the technological revolution, and financial innovations like the creation of mathematically complex credit derivatives. All of them have some impact, but they find that the change with the single greatest explanatory power is deregulation, which they calculate has driven nearly a quarter of the increase in incomes in finance and 40 percent of the increase in the education of workers in that sector. Volcker and his smartest classmates chose to become professors and civil servants. Today, many of Harvard’s smartest economists choose Wall Street.
Emerging market oligarchs who owe their initial fortunes to sweetheart privatizations are perhaps the most obvious beneficiaries of rent-seeking. But through financial deregulation, western governments, especially in Washington and London, played an even greater role in the rise of the global super-elite. As with the sale of state assets in developing economies, the role of deregulation in creating a plutocracy turns classic thinking about rent-seeking upside down. Deregulation was part of a global liberalization drive whose goal was to pull the state out of the economy and let market forces rule. But one of its consequences was to give the state a direct role in choosing winners and losers–in this case, giving financial engineers a leg up.
Christopher Meyer, a management consultant at the Monitor Group, recently wrote a book about emerging market businesses and how they will reshape the global economy. Rent-seeking is obviously a big part of his story. But when I asked him which country’s businesspeople were the world’s champion rent-seekers, his answer surprised me: “In the financial industry, the United States had the most co-opted regulatory apparatus.” He went on to explain: “They are so innovative. They are driven to do it, and they’re doing a great job of what they’re paid to do. I don’t think this comes out of evil. I think this comes out of what we call runaway effects. The more you get incented to do it, the more you do it. And because so much of our incentive system is financial, then that’s what we got. We’re getting what we pay for, literally. And so Wall Street’s done a fabulous job of making the world safe for Wall Street.””
(THE FOLLOWING ARE MORE SEGMENTS FROM DIFFERENT AUTHORS IN PRAISE OF THIS BOOK AND I QUOTE:
“Our world increasingly revolves around global elites who not only have an oversized effect on our politics but also set the trends and furnish us with the dominant discourse. In this delightful book, Chrystia Freeland tells the story of how we go there and what distinguishes our elites from those of previous epochs. Most important, she explains why the elites’ dominance, even when it appears benign, is a challenge to our institutions and gives us clues about how we can overcome it.”
–Daron Acemoglu, coauthor of Why Nations Fail; economics professor, Massachusetts Institute of Technology
“The world’s wealthy elite are more wealthy, more knit together, more separate from their fellow citizens, and probably more powerful than ever before. This very important book describes their lives and, more important, how their lives affect all of ours. It should be read by anyone concerned with how their world is being shaped and how it will evolve.”
–Lawrence Summers, former U.S. Treasury secretary; Charles W. Eliot University Professor, Harvard University
LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran