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The Financial Times’ Martin Wolf Discovers that Rentier Capitalism and Financialization Increase Inequality and Hurt Growth

Summary:
Surprisingly, no one commented on a link to an important article by the Financial Times’ esteemed economics editor, Martin Wolf, Martin Wolf: why rigged capitalism is damaging liberal democracy, that weighed in as a major feature, as opposed to his usual column length. Wolf’s article is noteworthy by virtue of singling out, above all, rentier capitalism as the underlying culprit in rising inequality and disappointing productivity growth, and depicts financialization as one of the biggest contributors. On the one hand, readers of this site are very familiar with these arguments, particularly via Michael Hudson’s long-standing focus on how neoliberal economists chose to ignore a key insight of classical economists, that rentiers are a drag on productive activity and governments need to keep

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Surprisingly, no one commented on a link to an important article by the Financial Times’ esteemed economics editor, Martin Wolf, Martin Wolf: why rigged capitalism is damaging liberal democracy, that weighed in as a major feature, as opposed to his usual column length. Wolf’s article is noteworthy by virtue of singling out, above all, rentier capitalism as the underlying culprit in rising inequality and disappointing productivity growth, and depicts financialization as one of the biggest contributors.

On the one hand, readers of this site are very familiar with these arguments, particularly via Michael Hudson’s long-standing focus on how neoliberal economists chose to ignore a key insight of classical economists, that rentiers are a drag on productive activity and governments need to keep them in check. One of the favored policy of classical economists was usury ceilings. If lenders could charge whatever they wanted, funds would go to wealthy gamblers, who would out of recklessness or desperation, pay high rates, as opposed to productive industry. Similarly, we’ve posted on or linked to many economic studies that started to crop up when secular stagnation was a hot topic, and concluded that overly large financial sectors were a drag on growth. One of the particularly unproductive activities is secondary market trading and asset management. For instance, a 2015 study by the IMF found that the optimal level of development of a banking sector was that of Poland. A bigger finance sector might be OK only if it were tightly regulated.

On the other, Wolf is a barometer of leading edge conventional wisdom, so his calling out rentiers and Big Finance is a sign of a major shift underway, if nothing else, splits among the elites. Admittedly, the editors downplayed both of Wolf’s big points via their title and subhead, and Wolf arguably buried his lede by a first explaining that all is not well in the economy, a fact that in fairness may not be obvious to the top 10%ers that constitute the pink paper’s audience.

But Wolf makes no bones about his big message:

So why is the economy not delivering? The answer lies, in large part, with the rise of rentier capitalism. In this case “rent” means rewards over and above those required to induce the desired supply of goods, services, land or labour. “Rentier capitalism” means an economy in which market and political power allows privileged individuals and businesses to extract a great deal of such rent from everybody else….

Finance plays a key role, with several dimensions. Liberalised finance tends to metastasise, like a cancer. Thus, the financial sector’s ability to create credit and money finances its own activities, incomes and (often illusory) profits….

Finance also creates rising inequality. Thomas Philippon of the Stern School of Business and Ariell Reshef of the Paris School of Economics showed that the relative earnings of finance professionals exploded upwards in the 1980s with the deregulation of finance. They estimated that “rents” — earnings over and above those needed to attract people into the industry — accounted for 30-50 per cent of the pay differential between finance professionals and the rest of the private sector. 

Wolf criticizes other forms of rent-seeking, such as tax avoidance.

The reluctance to acknowledge the importance of rentiers is because it contradicts the all-important legitimator of our class structure, that of meritocracy. God forbid that most people who attend top colleges do so because their parents directly or indirectly greatly improved the odds for them, via giving to the schools, sending the children to high-standards private schools, paying for tutors, arranging for them to do eye-catching, impressive-sounding things over their summer breaks.

We wrote many years ago that meritocracy is unattainable. From a 2007 article in the Conference Board Review:

OK, so diversity programs may not serve the people they are designed to help. One of the reasons is that these initiatives are assumed to undermine merit-based hiring and promotion. Indeed, as [transgendered Stanford professor Ben] Barres points out, citing research, “When it comes to bias, it seems that the desire to believe in a meritocracy is so powerful that until a person has experienced sufficient career-harming bias themselves they simply do not believe it exists.” But the idea that an organization can be truly meritocratic is, alas, a fiction.

On a practical level, the best a company can hope for is that, taken as a whole, the people it hires and promotes are “better”—as defined by the com- pany—than the people it rejects. On an individual level, the role of luck, com- bined with inherent shortcomings of per- formance-appraisal systems, make it im- possible to have confidence in the fairness and accuracy of any particular staffing decision….

Now, for most people, it’s well nigh impossible to pick apart the importance of ability versus good fortune….Other factors can thwart an organization’s meritocratic efforts (many of these observations derive from a 1992 paper by Patrick D. Larkey and Jonathan P. Caul- kin, “All Above Average and Other Unintended Consequences of Performance Appraisal Systems”). Many people, for instance, run up against conflicts between individual and organizational interests. Implicitly, any employee’s job is to serve his boss, when his check is actually being cut by the company. If the employee views his role as being different than his boss sees it, the boss’s view prevails, whether or not it is correct. In an extreme case, if the boss wants the employee to run personal errands, and the employee refuses, he runs the risk of getting a neg- ative review.

There’s the Peter Principle conundrum that the skill requirements at one level may bear little relationship to the demands of the next. You’ve heard the old chestnut, “Promote your best salesman, and you lose a good salesman and gain a lousy manager.” But this situation puts bosses in a real bind. If you promote the person who is best in a department, his skills may fall woefully short of the requirements of his new role. But if you promote the person you deem best suited for that job, and not the top performer at his current role, you will demoralize his former peers, create resentment against him (undermining his authority and effectiveness), and raise questions about your
judgment.

And then there are difficulties in ranking employees across organizational units….

But most people recoil from the notion that society is capricious or deeply unfair. Yet MIT professor Simon Johnson in many ways went further than Wolf in his famous 2009 Atlantic article, The Quiet Coup. Johnson didn’t simply point out how the average compensation of employees in finance, once on a par with all workers, had started moving up even as employment in the banking sector also rose. He had no compunction about depicting the US as an finance-led oligarchy long before that was respectable:

Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks….As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise….

Squeezing the oligarchs, though, is seldom the strategy of choice among emerging-market governments. Quite the contrary: at the outset of the crisis, the oligarchs are usually among the first to get extra help from the government, such as preferential access to foreign currency, or maybe a nice tax break, or—here’s a classic Kremlin bailout technique—the assumption of private debt obligations by the government. Under duress, generosity toward old friends takes many innovative forms. Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk—at least until the riots grow too large.

In the US, the middle and lower classes took the big hits. 9 million foreclosures, many of which could and should have been avoided. A wipeout of black wealth. Protracted negative real interest rates, which economist Ed Kane described as a $300 billion a year transfer from savers to banks.

So why have economists who got it right, early, like Hudson and Johnson, been largely ignored as their colleagues chewed over why the recovery was so weak? Why, until a few years ago, was the work of Emanuel Saez and Thomas Piketty on rising inequality, politely noted but not seen as a cause for concern?

Johnson had it right. As he and others, including yours truly, pointed out, the priority after the crisis was restoring status quo ante and not a reset, as occurred in the wake of the Great Depression. And the authorities convinced themselves they’d done a good job because they didn’t see evidence that the pain was more than the patient would tolerate.

But the riots did come. It was in the form of Trump, and Farage, and Johnson.

And this blowback likely explains the odd emphasis in the article, of denying that globalization has played much of a role in the story of flagging first-world growth and rising inequality. One economist dismissed Wolf’s assertion: “The claim is absurd on its face.”

Wolf acknowledges that a lot of manufacturing moved to China. The Stolper-Samuelson theorem led to the conclusion that in sectors exposed to international trade, lower-skilled laborers in generally high-skill countries will suffer as trade volumes rise. Wolf airily responds with what amounts to “Let them eat training”:

The shift in the location of much manufacturing, principally to China, may have lowered investment in high-income economies a little. But this effect cannot have been powerful enough to reduce productivity growth significantly. To the contrary, the shift in the global division of labour induced high-income economies to specialise in skill-intensive sectors, where there was more potential for fast productivity growth.

Please tell me how a country as big as the US specializes in skill intensive sectors, yet provides enough jobs, particularly since outsourcing and offshoring is already making substantial inroads into “skill intensive” work like computer programming and the law. For the last decade plus, Slashdot regularly features an article from a new computer science graduate lamenting at the lack of entry-level jobs, and oldsters confirm his dire take. Robert Cringley has written at length how Silicon Valley companies all hired Indian outsourcers even though they know the results will be inferior (and not even necessarily cheaper) than hiring well-trained Americans, yet they are caught in a frenzy to cut costs to boost stock prices:

Now let’s look at what this has meant for the U.S. computer industry.

First is the lemming effect where several businesses in an industry all follow the same bad management plan and collectively kill themselves…

The IT services lemming effect has companies promising things that can not be done and still make a profit. It is more important to book business at any price than it is to deliver what they promise. In their rush to sign more business the industry is collectively jumping off a cliff.

This mad rush to send more work offshore (to get costs better aligned) is an act of desperation. Everyone knows it isn’t working well. Everyone knows doing it is just going to make the service quality a lot worse. If you annoy your customer enough they will decide to leave.

In the legal business, research, which is yeoman’s work, has been sent overseas for years and now is also being displaced by AI. So how will we train the next generation of lawyers?

Wolf also laments the loss of competitiveness, as measured by a fall in new business starts, while business deaths haven’t dropped as sharply. While, following other economists, Wolf fingers the rise in monopolies, the more obvious perp again is financialization. The drop starts in the early 1980s, just as the finance boom began. Remember how Wall Street was hoovering up quants? And in the 1990s, it was not hard to hear of scientists looking for a way to join the finance gravy train. In the last fifteen years, student debt has almost certainly put a damper on young people taking an entrepreneurial flier.

This is a long-winded way of saying that while Wolf is finally willing to say some taboo words out loud, he goes overboard in depicting Trump as all wrong. Trump does have occasional insights, but even with them, he seems to think that throwing enough Presidential weight around will change things, or at least create enough of an image of Doing Something to allow him to take credit for achieving progress.

While it’s easy to decry Trump’s theatrics and bullshitting, it seems awfully naive to see the recent Corporate America public recanting of shareholder capitalism as more than a combination of eyewash and self-delusion. Even though CEOs don’t like short-termism much, they are badly out of the habit of being accountable to broader constituencies, particularly workers. It’s hard to see their old habits changing any time soon.

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