They steal and steal and steal. They are stealing absolutely everything and it is impossible to stop them. But let them steal and take their property. They will become owners and decent administrators of this property.
Eating increases the appetite.
Raghuram Rajan is a professor at the University of Chicago, the intellectual home of free market economics. He is also a former chief economist of the International Monetary Fund, another institution not known for its hostility to global capitalism. A tall, slim forty-nine-year-old, Rajan favors the pressed button-down shirts and short, neat hair of an investment banker, rather than the stereotypical rumpled tweeds of a college teacher. In 2008 he returned to his native India to address the subcontinent’s most prestigious business association, the Bombay Chamber of Commerce and Industry, which, founded in 1836, was largely responsible for the first railway built in India and whose members’ wealth could buy about a third of India’s annual economic output. But Rajan was there to caution his country’s rising capitalists, rather than to rally them.
India, he said, risked becoming “an unequal oligarchy, or worse, perhaps far sooner than we think.” One piece of evidence Rajan cited was a spreadsheet compiled by Jayant Sinha, an old classmate of his from the Indian Institute of Technology, the country’s MIT and alma mater to many of its software entrepreneurs. Sinha had calculated the number of billionaires per trillion dollars of GDP in a number of countries around the world. Russia, with eighty-seven billionaires and a national GDP of $1.3 trillion, had the highest billionaire-to-GDP ratio. India, Rajan said, was number two, with fifty-five billionaires and $1.1 trillion of GDP.
Rajan assured his audience that he had nothing against billionaires per se: “We should certainly welcome it if businessmen make money legitimately.” But he argued that India’s high billionaire-to-GDP ratio was “alarming” because most of the country’s super-rich weren’t software pioneers or inventive manufacturers. Instead, “too many people have gotten too rich based on their proximity to the government…. Land, natural resources, and government contracts or licenses are the predominant sources of the wealth of our billionaires and all of these factors come from the government.
“If Russia is an oligarchy,” Rajan warned the assembled magnates, “how long can we resist calling India one?”
In the wake of the financial crisis, some critics have warned that America, too, risks becoming an oligarchy. Simon Johnson, another former chief economist of the IMF, has compared the bankers of the world’s superpower to emerging market oligarchs, arguing that they similarly have succeeded in diverting national resources—notably the bailout trillions—to themselves. The financiers, he says, have pulled off a “quiet coup.”
Johnson and Rajan have a shared concern: in an age of super-wealth, we need to be constantly alert to efforts by the elite to get rich by using their political muscle to increase their share of the preexisting pie, rather than by adding value to the economy and thus increasing the size of the pie overall. As the gap between the super-rich and everyone else has grown, enrichment through reallocation—which economists call “rent-seeking”—has become a hot political issue. It is one thing for Steve Jobs, whose products are so often objects of adoration, or even Bill Gates, whose products are so often instruments of torture, to accumulate billions. It is quite another for multimillion-dollar compensation to be paid to bankers whose institutions were bailed out by taxpayer trillions, or private equity fund managers who pay 15 percent tax on most of their earnings, or for the CEOs of multinational companies to take home higher paychecks than their billion-dollar firms pay in tax in the United States.
That’s why today rent-seeking is a favorite theme for the left. But as a field of formal study, rent-seeking was most energetically elaborated by economists on the right: it is, after all, the product of state control and distribution of wealth, something the right has been in the business of trying to decrease. And as inequality rises in twenty-first-century America, some on the right have returned to the idea that the central economic ill is rent-seeking. Speaking about “The American Idea” at the Heritage Foundation in the fall of 2011, Paul Ryan, the wonkish Wisconsin congressman, argued that, rather than raise taxes on individuals, we should “lower the amount of government spending the wealthy now receive.” The “true sources of inequity in our country,” he continued, are “corporate welfare that enriches the powerful, and empty promises that betray the powerless.” The real class warfare that threatens us, he said, is “a class of bureaucrats and connected crony capitalists trying to rise above the rest of us, call the shots, rig the rules, and preserve their place atop society.”
Here’s another paradox: some of the most egregious examples of rent-seeking in recent decades have been the unintended consequence of liberal reforms designed to loosen the state’s grip on the economy. These range from the transformative privatizations in formerly centrally planned economies to the deregulation of the financial sectors of the Anglo-American economies.
Rent-seeking also takes the more classic form of powerful groups using their influence to bend the rules of the economic game in their own favor. That is easiest to do, of course, when you control the state—which is why, for instance, Nicaragua’s authoritarian Somoza family and Mir Osman Ali Khan, the last hereditary prince of the Indian state of Hyderabad, both appear on lists of the richest families of the twentieth century. Finally, innovators can be rent-seekers if they become so successful their companies become monopolist. That was true of the railroad barons in the late nineteenth century and Microsoft in the late twentieth century, and surely will be of some twenty-first-century entrepreneur.
October is the best month to visit Kiev. The leaves of the horse chestnut trees that line the Khreshchatyk, the wide boulevard that is the Ukrainian capital’s central artery, range from dark green to bright yellow, the average high temperature is a crisp sixty-three degrees, and the central European sun isn’t yet obscured by the clouds of November.
But on October 24, 2005, attention was turned indoors, to an undistinguished room inside the State Property Fund, a grim Soviet-era building in the exclusive Perchersky neighborhood. On this autumn day, industrialists from as far afield as India and Luxembourg, the international press, some 150 demonstrators, and the nation’s television cameras, broadcasting live, converged on the State Property Fund to participate in an event of unlikely drama: the auction of Kryvorizhstal, Ukraine’s largest steel mill.
The starting price was $2 billion. In a three-way fight between Mittal Steel, based in Europe and owned by the Indian Mittal dynasty; Luxembourg’s Arcelor, working in concert with eastern Ukrainian oligarchs; and the LLC Smart Group, a Dnipropetrovsk-based consortium of Russians and Ukrainians, the number quickly soared to more than double that amount.
“Once more, I am reminding you that on the table is the package of shares for the Kryvorizhstal company,” the auctioneer, wearing an ordinary business suit, reminded the bidders and live television audience forty minutes into the proceedings. “Participant number three [Mittal Steel] bids a price of 24,200 million hryvnias [$4.8 billion]. Three! Sold to participant number three.”
Recently ousted prime minister Yulia Tymoshenko, wearing her characteristic coronet of wheat-colored braids and displaying her equally characteristic sense of theater, was the first to congratulate Lakshmi Mittal, the family’s second-generation steel man and its reigning patriarch. “It was like a football game!” she said triumphantly.
The oligarchs, she told me when we met later (and after she had been reinstalled as prime minister), “hate me—they don’t understand me because… they cannot buy me or scare me.” She was both right and wrong. In 2011, after Viktor Yanukovych, whose candidacy was backed by several eastern Ukrainian oligarchs, was elected president, he imprisoned Ms. Tymoshenko, in a politically motivated case redolent of Mikhail Khodorkovsky. She still isn’t scared, though, and was defiant both in the dock and in statements from jail.
The auction was certainly a moment of high political drama for Ukrainians. The democratic Orange Revolution, which Ms. Tymoshenko helped lead, had swept to power ten months earlier partly thanks to public revulsion at the 2004 privatization of Kryvorizhstal, for just $800 million, to a consortium that included the then president’s son-in-law. The 2005 reprivatization, at a price that was six times higher, was both a fulfillment of one of the Orange Revolution’s central promises and a vindication of one of its chief complaints.
But the Kryvorizhstal auction is also the central drama in an even bigger story. Of all the state-owned assets in the entire former Soviet Union sold to private owners since 1991, when the USSR collapsed, the one with the very highest price tag is Kryvorizhstal. That is an astonishing fact. In the two decades since the end of Soviet communism, the successor states have privatized oil companies that control around one hundred billion barrels of crude oil reserves, a mine that produced 25 percent of the world’s nickel, a major diamond producer, and a vast aluminum industry. But it is a Stalin-era steel mill in a grim and anonymous city in southern Ukraine that, if cost is any measure of value, turns out to have been the crown jewel in the former Soviet Union’s natural resource and industrial patrimony.
That, of course, is absurd. Which is why the real story of Kryvorizhstal isn’t the successful multibillion-dollar sale of a Ukrainian steel mill to an Indian magnate, it is how it dramatizes the vast giveaway of the rest of the assets of the former Soviet Union. That shift from state to private ownership is probably the single largest transfer of assets in human history. When it comes to the creation of twenty-first-century billionaires, the USSR’s sale of the century is also the most powerful driver, more important than Silicon Valley’s technology revolution or the flourishing of finance on Wall Street and in the City of London. Just consider: of the 1,226 billionaires on the Forbes 2012 rich list, 111 were oligarchs from the former Soviet Union, 90 were technologists, and 77 were financiers. The number of billionaires relative to the size of the economy and the gap between the billionaires and everyone else are even more striking: The fortunes of Russia’s billionaires could buy roughly a fifth of the country’s annual economic output. Compare that with the United States, whose 424 billionaires could buy just over 10 percent of their country’s annual economic output, or South Korea, whose 20 billionaires could afford just 4 percent of their country’s yearly economic output. Forbes declared that in 2012, Moscow was the world’s “top city” for billionaires, boasting 78 of them, compared with just 58 in New York, and nearly double London’s 39. Indeed, economic historians have found that Russia’s oligarchs have done so well for themselves that inequality today is higher than it was under the tsars.
The fire sale of the assets of the former Soviet Union stands out because it marked such a sharp shift from nearly total state ownership, because the loot that was privatized was so valuable, and because the transition was so swift. But it was also part of a wider global trend. If you ever doubt that ideas matter, consider the astonishing, bloodless victory of liberal economic thinking and its concrete impact around the world in the last two decades of the twentieth century. The two great behemoths of state ownership—the former Soviet Union and China—shifted vast assets into private hands. Mixed economies in the developing world like India, Mexico, and Brazil sold off state companies and natural resources. Western capitalist countries, led by Britain, sold off companies that had once been considered natural monopolies and spun off the provision of many services that had once been thought best performed by the state.
Everywhere, the goal was to get the government out. But the irony of the victory of the liberal economic idea is that putting it into practice delivered the greatest rent-seeking windfall in economic history—the state, after all, was in charge of privatization. Influencing that one-off division of the spoils was one of the surest ways to join today’s global super-elite.
In fact, according to calculations by Branko Milanovic, the richest man who ever lived isn’t a Russian oligarch, but he does owe much of his fortune to the great wave of liberalization that swept the world when Soviet communism collapsed.
Comparing income across history is hard. The conversion tools we use to make comparisons across geographies today—currency exchange rates or the more subtle measure of purchasing power parity—are ineffective when the goods we consume—horses vs. private jets or personal scribes vs. iPads—are so different. Milanovic gets around this mismatch by turning to Adam Smith. His yardstick of wealth was how much of our compatriots’ work we can buy: “A person must be rich or poor according to the quantity of labor which he can command.” Among today’s billionaires, Milanovic’s calculations favor the rich man in a poor country—he can employ more of his less well-paid compatriots. If anything, it is also a measure that overstates the wealth of the ancients—after all, no matter how rich you were in Rome or Egypt, what today are ordinary middle-class services like telephones or airplane travel were in those days luxuries that were literally unimaginable. What Milanovic’s approach may understate is the power gap between ancient oligarchs and everyone else: many owned slaves or serfs, whom they were free to beat or kill, and some could raise their own armies, which rivaled the power of the relatively weak state.
Marcus Crassus, who lives on today as a cartoon villain in video games based on Spartacus’s slave revolt, which he helped crush, was famous in his own time as the wealthiest man in Rome. He was nicknamed “Dives” or “the Rich” and successfully defended himself when charged with the capital crime of corrupting a vestal virgin by explaining he was after the maiden’s money, not her virtue; his fellow Romans thought that account rang true to character. Plutarch estimated Crassus’s fortune at 170 million sesterces; Pliny the Elder put it a little higher, at 200 million. That second estimate was roughly the size of the entire government treasury of the Roman empire. Gauged by Milanovic’s metric, Crassus’s fortune translated into an annual return that was equal to the average yearly income of thirty-two thousand Romans.
That’s a lot, but Crassus was handily outearned by the first generation of plutocrats, the robber barons of the Gilded Age. Andrew Carnegie’s wealth was at its apex in 1901, when he purchased U.S. Steel. His share in the company was worth $225 million, which yielded an annual income the same as that of 48,000 average Americans. John D. Rockefeller did even better: his peak fortune of $1.4 billion in 1937 yielded an annual income equal to that of 116,000 Americans.
But all three are trumped by the man at the head of the 2012 Forbes global rich list, Mexican tycoon Carlos Slim. Forbes put Slim’s fortune that year at $69 billion, enough to earn an income equivalent to the average annual salary of more than 400,000 Mexicans. Here’s another way to see Slim’s relative economic weight in Mexico: His fortune could buy 6 percent of Mexico’s annual economic output. At his peak wealth, Rockefeller could buy less than 2 percent of the U.S. annual output. Bill Gates, America’s top dog in the twenty-first century, could afford less than 0.5 percent of the country’s yearly economic output. If you make a telephone call, smoke a cigarette, go to the bank, take a flight, or ride a bike in Mexico, you probably pay a few pesos to Slim. His presence is so ubiquitous that one restaurant in the capital quips on its menu that it is the only place in Mexico not owned by Slim.
Like the Russian oligarchs—as it happens, Milanovic thinks the second-richest person of all time was oil baron Mikhail Khodorkovsky, who he calculates could buy the labor of a quarter of a million Russians in 2003, the year before Khodorkovsky was arrested—Slim owes his leap from millionaire to billionaire to the wave of economic liberalization that swept the world, particularly the previously state-dominated emerging market economies, in the nineties. In Slim’s case, the windfall was telecom privatization.
That sale was orchestrated by Carlos Salinas, a Harvard-educated technocrat determined to reform a stagnant Mexican economy whose growth was constrained in part by the dominance of inefficient, state-controlled companies. Like the liberals who spearheaded Russia’s great sell-off, Salinas was a true believer in market reforms. And he believed in Slim, whom he had befriended in the eighties. That was a rough decade—the 1982 nationalization of the country’s banks and the plummeting price of oil had provoked capital flight and weakened economic growth—but Slim, building on his family’s retailing fortune and his own balance-sheet brilliance, held his nerve and bought assets on the cheap, expanding into cigarette production and insurance. Salinas liked Slim’s commitment to the country, his ability to see opportunity at a time of peril, and his entrepreneurial verve. The pair were dubbed “Carlos and Charlie’s” after a cheap and cheerful local restaurant chain.
Slim was a vocal supporter of his friend’s reform effort, speaking in favor of the plan in both public and private and lobbying politicians and the media to back it, too. When Telmex, the country’s telecom monopoly went on the block, he pounced. Unlike so many of the post-Soviet privatizations, Telmex was auctioned off for real money—$1.76 billion, for a more than 20 percent controlling stake, which was widely considered reasonable at the time. (Even at that healthy price, one of the losing bidders, and an erstwhile close friend of Slim’s, Roberto Hernández, has suggested the auction was rigged. Both Slim and Salinas have repeatedly denied that charge.)
Telmex’s privatizers were right to argue that the state monopoly had done a dreadful job serving Mexicans. Before Telmex was sold off, the average wait for a telephone line was a year, and only one-quarter of Mexican homes had a phone. But the sale was also a rent-seeker’s dream. That’s partly because, to dress up Telmex on the auction block and make the privatization a political success in the short term, the winner was offered a six-year extension of the company’s national phone monopoly and the only national cell phone license.
These formidable advantages were enhanced by a remarkably weak regulatory setup. The sale itself was conducted by the finance ministry, rather than the telecommunications ministry, and a telecom regulator was created only three years after the Telmex privatization. Once it was up and running, the regulator was severely outgunned; its annual budget was just a couple of days’ revenue of the Slim telephone businesses. Even when regulators do rule against Telmex, as a study by Mexican and American political scientists Isabel Guerrero, Luis-Felipe López-Calva, and Michael Walton has found, the company is very effective at using amparos, a Mexican court injunction that allows government rulings to be blocked, to delay unfavorable decisions. When Salinas’s party, the PRI, gave way to Vicente Fox, Mexico’s first president elected by the opposition party in decades, Slim’s cozy relationship with the state endured—Fox named a former Telmex employee, Pedro Cerisola, as minister of communications and transport.
The result has been lucrative market dominance for the Slim telecom empire, which controls about 80 percent of all fixed lines, and about 70 percent of all cell phones. One consequence of that near-monopoly control is low investment in innovation—Mexico’s is among the lowest in the OECD. Indian companies filed five telecom patents in 2001 and thirteen in 2005; Mexican firms didn’t file any between 1991 and 2005. Another is high price. Within the OECD, Mexican businesses pay the highest rates for a basket of cell lines and landlines; Mexican individuals pay the second-highest rate. As a result, in 2007 half of Mexicans had a landline telephone and 60 percent had a cell phone. That is a great improvement on 1990, but a poor performance compared with a country like Turkey, which has roughly the same per capita GDP as Mexico but a phone penetration of 75 percent.
Slim is the biggest beneficiary of Mexico’s liberalization, but he isn’t its only one. In 1991, shortly after Salinas launched his reform drive, there were two Mexicans on the Forbes billionaire list. In 1994, at the end of the Salinas presidency, there were twenty-four. Like Slim, Mexico’s other billionaires were enriched not only by the initial sell-off of state assets, but also by an ongoing ability to influence the rules of the economic game. The political scientists who rated Slim’s success at getting telecom judgments that helped Telmex did a broader calculation of the legal effectiveness of the country’s plutocrats. They found that billionaires were three times more likely than other plaintiffs to win rulings in their favor and triumphed over state regulators an average of three out of four times when their disputes went to court.
The rise of the Mexican and former Soviet privatization billionaires is an easy target, because the broader impact of liberalization on their countries’ economies has been mediocre. Mexico grew by an average of 3.5 percent a year in the 1990s and under 2 percent a year in the first decade of this century. Russia, after a sharp decline following the collapse of communism, has grown by an annual average of over 4 percent since 2000. Those are good numbers, but they pale in comparison with the performance of emerging market tigers like China, where average annual growth over the past decade has been 9 percent; India, which averaged 7 percent; or Brazil, which grew at an average rate of over 3 percent.
But as Rajan warned his audience at the Bombay Chamber of Commerce, even in India, with its stellar economic growth and democratic political system, rent-seeking is turning out to be a very effective way to join the super-elite.
It wasn’t supposed to turn out this way. Manmohan Singh, another idealistic technocrat who became prime minister in 2004, had brought the global market reform revolution to India in 1991 when he was finance minister. The animating idea was to liberate the country from the License Raj, a protectionist system that sheltered state-dominated firms and the privately owned national champions who were in on the game. The old system was a good deal for government officials and for the private firms granted access to the License Raj, but it was a poor setup for everyone else. India’s GDP increased at a sleepy average of around 3 percent in the decades between independence and 1991—known, with self-deprecating irony, as “the Hindu rate of growth”—and India’s consumers, who were poor to begin with, had their purchasing power further eroded by being limited to more costly and lower-quality domestic goods.
Like Soviet communism, which had been a partial ideological inspiration for “third-way” India—when he trained as an economist in the 1970s, one of Singh’s projects, like that of all Indian economists of his generation, was learning how to create a five-year national central plan—the License Raj was a rent-seeking dystopia. Singh’s reforms were meant to end that systemic corruption and create an economy where the way to get rich was by producing more, better, and cheaper goods and services.
By many measures, the reforms were a dazzling success. The Indian economy grew an average of 7 percent in the past two decades, and average annual per capita income nearly quadrupled between 1991 and 2011. But on the road to the market, Indians have had one unwelcome surprise. Ending the License Raj hasn’t ended rent-seeking. In fact, government connections are probably more lucrative today than they were in the old system.
As in other liberalizing emerging markets, India’s reforms have been a hugely effective mechanism for billionaire creation. India had just one billionaire in 1991, on the eve of Singh’s reforms. In 2012, there were forty-eight. With a fortune of $22.3 billion, Mukesh Ambani was the richest Indian in 2012. He had just under a third of the wealth of Slim and, because India is so vast, a fraction of his control of the national economy. As a group, though, India’s plutocrats—the forty-eight billionaires—in 2012 had a combined net worth equal to more than 14 percent of their country’s GDP. That’s equal to the economic footprint of America’s 424 billionaires.
The rent-seeking side of Indian capitalism became a dramatic part of the national conversation in 2010, when tapes tax investigators had made of more than 140 conversations of Niira Radia, a glamorous Delhi lobbyist, were leaked to the media. In the hundreds of hours of talk between Radia, businessmen, journalists, and politicians, ministries are described as ATM machines and the ruling party is called “our shop.” She is explicit about how lucrative mobile phone licenses were allocated: “When it came to spectrum, they went to [Andimuthu] Raja [the telecommunications minister] and paid him a bribe and got spectrum allocated,” she tells a rival businessman.
One measure of the impact was an Indian version of the popular protests that swept the world in 2011, from Tahrir Square to Zuccotti Park. The subcontinent’s 99 percent coalesced around Anna Hazare, a veteran activist whose anticorruption hunger strike rallied the country’s hitherto quiescent urban middle class and may lead to the creation of a stronger anticorruption investigative body.
One of Hazare’s top lieutenants is Dr. Kiran Bedi. Bedi is a national legend in her own right. She was the first Indian woman police officer—officials asked her to consider another career when she applied to join the force in 1972—and rose to be the head of its investigative division. She once doused herself in water from a street fountain before running into a burning building to lead her team in the rescue of its seventeen occupants. She is equally famous for having Indira Gandhi’s car towed for parking illegally—a beloved signal that no one was above the law. When I met Dr. Bedi in Mumbai in 2011, she was a sixty-one-year-old grandmother with glasses and her black hair trimmed in a brisk boyish haircut. Bedi is small—she claims five feet, three inches—and was once lifted from the ground by a student protester she was policing. She was dressed in a vibrant turquoise shalwar kameez that matched her energetic manner.
“India has been overwhelmed by corruption scams,” Dr. Bedi told me. “While it has been apparent that India is shining, India has also been declining in many ways in that there has been rampant exposure of corruption.
“It was a relationship of illicit wealth between the people in power and the people who had money,” Dr. Bedi said. “The rich could get richer by buying to be rich. They could afford to buy better contracts and those contracts which are expensive and monopolistic—the mining rights, the key infrastructure rights… They broke the balance of a level playing field for the younger and the newcomers, so therefore I think that was the imbalance which happened in the economy or in the distribution of the economy.”
Nor is it just the activists who have come to fear that alongside India’s remarkable economic surge the rot has been spreading, too.
“Corruption is endemic,” Rajiv Lall, the chief executive officer of the Infrastructure Development Finance Company, a partly state-owned financial institution, and the official who invited Rajan to give his Bombay Chamber of Commerce lecture, told me. “I don’t think anybody here is pretending that there’s no corruption in the country. And corruption can take on a new dimension, especially in this time of great transformation.”
“The Gini coefficient [an economic measure of income inequality] always rises whenever growth takes off,” Arun Maira, a former industrialist and now a member of the country’s influential planning commission, told me. “When you open more opportunity, like more free markets and the opportunity for people to do their own thing, those who already have some capital, or they have some education, or they have access to people in power so that they could help get access to the new opportunities more easily, they will first grow themselves, their own wealth. So you will get the people with something becoming richer faster than those who don’t have access to education, to some capital, and to the system.”
As Mr. Maira pointed out, one of the most powerful advantages of the 1 percent is “access to people in power.” Corrupt business deals are the most extreme use—and abuse—of those relationships. But there is a more subtle reason the game is most effectively played by those who are already winning it.
“The tendency is that people who have access to power and access to governments, etc., tend to get a better deal actually,” said Kris Gopalakrishnan, the cochair of Infosys, the pioneering Indian technology company. “The policies, the roots are framed because they are people who give inputs to those policies. Because you don’t ask everybody when policies get formed. You ask the key people I need to talk to.”
To understand what it is like to operate in a society where both opportunity and corruption are flourishing, I spoke to a young, up-and-coming Mumbai businessman. Raj, who is in his midthirties, agreed to be frank in exchange for my promise not to use his name (the details of his life are precise; the name is disguised). In America, where he went to business school, Raj would be a member of the 1 percent. In India, where he was born, Raj is part of the 0.1 percent, but he is no billionaire.
After getting his MBA at Duke, Raj went to work for one of the major consulting companies in New York; he still owns a one-bedroom apartment in the Flatiron district, which he bought partly as an investment and partly to maintain a connection with the city he loves. Two years ago, however, he moved to his company’s newly opened office in his hometown, Mumbai, and he plans to make the rest of his career in India. Raj believes the Indian economy will grow at least 7 percent a year for the next decade, creating a world of possibilities unimaginable in the slower-developing West. One example: in addition to his day job and his duties as the father of six-year-old and six-month-old daughters (his American-born wife works part-time at another multinational), Raj has founded his own company, which manufactures molded-plastic injection parts.
“You could be a billionaire if you moved to India, too,” he tells me. “All you need is the luck to meet the right government official and a willingness to risk going to jail.”
Raj is thriving both in his day job as a consultant and in his weekend shift at the factory. The consultancy is booming because “Indian firms are now going global.” One of his clients, for instance, whom Raj describes as a “midlevel player” with a net worth of around $500 million, is considering the acquisition of a company with operations in Mexico and Europe. “This globalization is new for Indian companies at this level, and it will be the big trend for the next five years,” he said.
Raj’s plastics business, which initially failed to take off but now is expanding at about 100 percent a year, is thriving for a different reason. “It took me a long time to figure out who to bribe in government to get a government contract,” Raj said. I asked if he minded paying backhanders. Not especially, he said, but he wished it had been easier and quicker to identify and befriend the right decision maker in the civil service.
On March 5, 2012, the three thousand members of the National People’s Congress gathered in Beijing for their annual ten-day meeting. The National People’s Congress is nominally the highest governmental body in China. In practice, real power resides with the twenty-five-member Politburo and its Standing Committee. The National People’s Congress partly serves as a political Potemkin village, a rubber-stamp legislature whose role is to create a pretense of popular representation in what is an authoritarian system, just as the “elections,” with their 99 percent majorities, did in the Soviet era.
But the National People’s Congress isn’t purely ornamental. The NPC’s March meeting is held every year alongside the annual Chinese People’s Political Consultative Conference. Together, the two events are known as the lianghui—or two meetings—and they form the most important event on the Chinese political calendar. The lianghui let the world know which political faction is ascendant within the Communist Party—at the 2012 meetings Bo Xilai, the flamboyant party secretary of Chongqing and a powerful Politburo member, was publicly demoted, in a sign that the statist group, of which he was the most prominent member, was in decline—and which direction economic policy is likely to take. They are a forum at which political trial balloons can safely be floated and the private factional battles that are at the heart of China’s real politics can subtly be rehearsed before a wider audience.
Most important, in a country that brutally abolished hereditary social distinctions when Mao’s Communists came to power, the National People’s Congress is the closest China comes to a modern-day Debrett’s list—if you want to know who’s who in China, there’s no better place to start than the delegate list. That’s why a report published on the eve of the 2012 congress by the Hurun Report, the best source of intelligence on China’s rich, was so striking.
According to Hurun, the seventy richest members of the NPC made more money in 2011 than the total combined net worth of all the members of all three branches of U.S. government—the president and his cabinet, both houses of Congress, and the justices of the Supreme Court. The top seventy members of the NPC added $11.5 billion to their combined net worth in 2011, bringing their total to $89.8 billion. That 2011 gain of the top seventy Chinese legislators is more than 50 percent greater than the total net worth of all 660 members of the three federal branches of U.S. government, whose 2011 net worth was $7.5 billion. The contrast is equally striking when you compare the very richest members of the NPC with their U.S. equivalents. The wealthiest 2 percent of the NPC—the top sixty members—had an average net worth of $1.44 billion in 2011. The top 2 percent of U.S. legislators—eleven Congress members—had an average wealth of $323 million. Zong Qinghou, China’s beverage magnate with an estimated wealth of nearly $10 billion and one of the five richest men in China depending on the year, is a deputy of the NPC. Other business tycoons in the group include Lu Guanqiu, the chairman of the Wanxiang Group, China’s leading auto parts maker, and Wang Jianlin, a real estate developer.
These calculations by the Hurun Report were striking partly because, at a moment when American public opinion was becoming uncharacteristically agitated about the nexus of political power and money, they showed that when it came to creating billionaire politicians the Americans are pikers compared to the Chinese. More broadly, they are also a reminder that, for all its success in raising 300 million of its 1.3 billion citizens out of poverty since the introduction of market reforms in the late 1980s, Beijing has also created one of the world’s most conducive economies for rent-seeking. “There are skeletons behind every entrepreneur in China,” Rupert Hoogewerf, publisher of the Hurun Report, told a reporter.
We don’t often equate the rise of China with the rise of the red oligarchs. That’s partly because, unlike most economies that are friendly to rent-seeking, China has been so phenomenally successful: rent-seeking and the sustained high growth that China has experienced don’t often go together. It is also because, in contrast with the countries of the former Warsaw Pact, which transferred the property of the communist state into private hands with a big-bang sell-off, China’s market reforms have been slower and its avenues for rent-seeking have been more varied and more opaque than a quick privatization drive led from the top.
Finally, China’s billionaires are among the world’s most discreet. China’s rising bourgeoisie loves conspicuous consumption: gold is so popular you can buy it at ATMs, all the West’s great luxury brands are enjoying robust growth in China, and the market for the highest-end possessions—old wine and fine art in particular—is driven significantly by Chinese demand. In 2011, according to a study by the European Fine Art Foundation, China as a whole accounted for almost a third of the global art market revenue, outshopping the United States for the first time. But at the very, very top, China’s billionaires understand that notoriety is dangerous. The Russians invite British politicians to party on their yachts in the Mediterranean and buy sports teams in New York and London; the Indians vie to build the biggest mansion and to do the sexiest deal with a famous Western partner; the Latin Americans buy penthouses in Manhattan and stakes in U.S. media companies. While the Chinese state has been flexing its muscles in the Western political economy, Chinese billionaires, of whom there are ninety-five—the third-largest cohort in the world—are less visible. That is because they know that the Chinese regime—still, after all, a one-party communist state—is highly ambivalent about its plutocrats. Hence the party’s official policy of pursuing “harmonious growth” and Premier Wen Jiabao’s insistence, on the eve of the lianghui, that “we should not only make the cake of social wealth as big as possible, but also distribute the cake in a fair way and let everyone enjoy the fruits of reform and opening up.” “Four legs good, two legs better” is the politically dangerous contradiction at the heart of China today. One way to appease the restive four legs is to imprison the occasional Chinese plutocrat, which is why you probably can’t name a single one.
But if you have the self-discipline to fly below the radar, China is a rent-seekers’ paradise. That is because over the past few decades the Middle Kingdom has offered three lucrative routes to rent-seeking, and many of its billionaires have taken advantage of all of them. The Chinese hate comparisons with Russia’s capitalist transition—when my book on Russia’s sale of the century was translated into Chinese, the first question Chinese journalists always asked me was “How were the Russian market reforms a failure compared to the Chinese approach?”—but many of their plutocrats have been the beneficiaries of a slower and more opaque version of the same transition from total state ownership to some private property. Tellingly, both the Chinese and the Russians refer to the murky first fortunes of their liberalization-era plutocrats as their “original sins.”
Second, China has what you might call robber baron plutocrats: the rent-seeking billionaires who develop a network of government connections and use them to reap windfall fortunes at a moment of rapid economic growth—in China’s case, the shift from a poor, rural economy to an urban and industrial one. America doesn’t think too highly of its robber barons, but these, like the privatization plutocrats, are not the worst kind to have. Both use personal connections to unfairly benefit from a massive transition, and both capture value that a fair and effective state would have diverted to the common good. But both are also the beneficiaries, and very often the drivers, of an economic transition that transforms the economic prospects of the country as a whole. That’s why, over the past three decades, China’s average per capita income has risen from $200 to $5,400, and 50 percent of its people now live in cities, where the average income is over three times higher than in the countryside. The rent-seeking beneficiaries of these big shifts in the United States in the nineteenth century and in China over the past three decades were part of a change that had broadly shared benefits.
Third, and most important, rent-seeking in China isn’t just the result of a fast and turbulent economic transformation—though that is, of course, taking place. Making money through government connections isn’t a temporary, one-off thing in the People’s Republic, or a “corrupt” instance of rule breaking. In a state-capitalist system like China’s, making money by being close to the state isn’t an exception to the rules or a violation of them—it is how the system really works.
“What moves this structure is not a market economy and its laws of supply and demand, but a carefully balanced social mechanism built around the particular interests of the revolutionary families who constitute the political elite,” explain Carl Walter and Fraser Howie in their award-winning book on the Chinese economy, Red Capitalism. “China is a family-run business.
“Failure to grasp the impact of unbridled Western-style capitalism on its elite families in a society and culture lacking in legal or ethical counterbalances is to miss the reality of today’s China. Greed is the driving force behind the protectionist walls of the state-owned economy inside the system and money is the language.”
Unlike their Russian comrades, China’s red oligarchs didn’t get rich in a one-off privatization of the country’s natural resources. China hasn’t had a mass privatization moment, and it lacks Russia’s vast oil and metal wealth. Instead, China’s rent-seekers prospered through privileged access to the two essential economic goods the state does control: land and capital. A preponderance of China’s plutocrats, including Wu Yajun, the country’s wealthiest woman—and, of course, one of the delegates to the 2012 National People’s Congress—have made their fortunes in real estate. Because land use is still closely controlled by the state, that is a business which inevitably involves close ties with the government. And almost all businesses need credit. For all China’s success in nurturing private business, more than 90 percent of loans in the country are still made by state-controlled banks. To borrow, you need a favorable relationship with the state and its mandarins, something the bosses of state-owned enterprises, who are simultaneously business executives and senior government officials, have automatically. As Walter and Howie, who have worked in Chinese finance for decades, explain: “What would the chairman of China’s largest bank do if the chairman of PetroChina asked for a loan? He would say: ‘Thank you very much, how much, and for how long?’”
The subtle hand of the Chinese government in appointing its rising class of plutocrats—according to Hurun, there were 271 billionaires in China in 2011, and the cutoff to make the list of the one thousand wealthiest Chinese was $310 million—is perhaps most apparent in the emergence of red dynasties, whose scions are known as the “princelings.” These are the sons and daughters of today’s Chinese leadership, and often the grandchildren of the leaders of the Maoist revolution. They form an important political faction in the Chinese Communist Party, and many of them are plutocrats. Li Peng was China’s premier from 1987 to 1998. Today, his family are utility tycoons. His daughter Li Xiaolin, who has been called “China’s Power Queen,” serves as chair and CEO of China Power International Development, and his son Li Xiaopeng managed Huaneng Power International, the country’s largest independent power generator, before entering politics in 2008. Zhu Yunlai, son of Zhu Rongji, another former premier, who was in office from 1998 until 2003, is a senior executive at CICC, the Chinese investment bank, which counts the illustrious private equity firms KKR and TPG among its shareholders. In rent-seeking societies, the plutocrats are appointed by the state. Who better to appoint than your own children?
Another sign of the political nature of wealth in China is Beijing’s ability to defrock its oligarchs. That reversal of fortune is often dramatic—a strong predictor of China’s future jailbirds is its current rich list. In 2002, Zhou Zhengyi, who made his fortune in Shanghai real estate, was identified as the eleventh richest man in China, with a fortune of $320 million; in 2003, he was imprisoned on corruption charges. In 2008, Huang Guangyu, the Beijing-based founder of the GOME retail chain, was named the second-richest, by Forbes. In 2010, he, too, was jailed for corruption. The list goes on. The point isn’t that China’s plutocrats are squeaky clean and are being unjustly imprisoned—like all businesspeople in a rent-seeking society they have their original sins. But where all property involves, if not theft, then at least some rule bending and palm greasing, everyone is vulnerable. As The Economist noted in 2003, Zhou’s dealings were far from exceptional: “If they wanted to, China’s authorities could probably find grounds for accusing most of the country’s richest people of bending (if not breaking) the rules. But China’s legal culture thrives on the principle of ‘killing the chicken to scare the monkeys.’ Mr. Zhou… was a conspicuous potential chicken.”
The dramatic denouement of the March 2012 NPC is that now the biggest monkey is directly in the state’s sights, too. Bo Xilai, the charismatic former chief of the thirty-four-million-strong Yangtze River megalopolis of Chongqing, was one of the leading elite critics of China’s rising inequality: on the eve of the NPC he told reporters in Beijing that the country’s Gini coefficient had exceeded 0.46 (it is 0.45 in the United States) and warned: “If only a few people are rich, then we’ll slide into capitalism. We’ve failed. If a new capitalist class is created then we’ll really have turned into a wrong road.” But at the same time, Bo was a princeling—his father was Bo Yibo, one of the Eight Immortals of the Communist Party—and the patriarch of a clan with wealth as well as political power. His son Bo Guagua reportedly drove up in a red Ferrari to pick up a daughter of then U.S. ambassador Jon Huntsman for a date. (Guagua denies driving the Ferrari; the Huntsman daughter says she can’t remember the make of the car.) Guagua was educated at Harrow, the British public school with an annual tuition of $50,000; Oxford, where he helped organize the Silk Road Ball; and Harvard. Bo’s wife, Gu Kailai, is a lawyer who ran a lucrative international law firm, Kailai, and an advisory firm called Horus Consultancy and Investment. Since Bo Xilai’s fall from grace, the family’s documented fortune is now pegged at $136 million and the figure seems to rise every day.
In early March 2012, Bo was one of China’s rising leaders—he was seen as a strong candidate for membership in the Standing Committee of the Politburo, the nine-person body that rules China. Over the next five weeks, in the most dramatic political fight in the country since Tiananmen Square, Bo went from princeling to pariah, first losing his job and then facing investigation for “suspected serious violations of discipline.” Gu, his wife, has been charged with murder. The fall of Bo Xilai is partly a tale of red capitalism intrigue and skulduggery—the attack on the Bo clan began with the mysterious hotel death of a British national who worked with Gu and alleged efforts to block investigation of it. But it is also being read as a fight between the red oligarchs, personified by Bo, and the reformers, who are fighting for a more transparent and competitive system. As Stephen Roach, the former chairman of Morgan Stanley Asia who now teaches at Yale, told me, “The emphasis once again is shifting much more back to the reformers…. [Bo Xilai’s sacking is] very powerful evidence in favor of returning to this pro-reform, pro-private-enterprise, pro-market-based direction that China has been on for the last thirty-two years, barring a few pretty obvious bumps in the road from time to time.”
Professor Roach is right. Bo Xilai was China’s most visible advocate of state capitalism, a system rife with opportunities for rent-seeking. His downfall has been part of a wider drive to make the Chinese economy more fair and open, most notably Premier Wen Jiabao’s striking attack on state banks, an important source of wealth for the red oligarchs. As Wen told an audience of business leaders in remarks broadcast on China National Radio, “Let me be frank. Our banks earn profit too easily. Why? Because a small number of large banks have a monopoly…. To break the monopoly, we must allow private capital to flow into the finance sector.”
But as in the other emerging markets, and indeed in the West, too, understanding China’s great political struggle as a fight between venal red rent-seekers and virtuous market reformers doesn’t tell the entire story. Some of the most successful princelings are the children of some of China’s most effective market reformers, and even the entrepreneurs whose fortunes are largely based on creating real value needed a helping hand from the state to survive and thrive. To paraphrase Proudhon, in a country like China, where money and government are so intimately intertwined, all fortunes required a little rent-seeking.
On January 22, 2007, Mike Bloomberg, the mayor of New York, and Chuck Schumer, the senior senator for the state, released a study they had commissioned from McKinsey, the world’s leading management consultants. The report, titled “Sustaining New York’s and the US’ Global Financial Services Leadership,” warned of impending financial crisis and offered detailed guidance on how to avert it.
Less than seven months later, the greatest financial crisis since the Great Depression did indeed begin, when BNP Paribas, the French bank, froze withdrawals from three of its funds, a step we would see in hindsight as the opening shot in the economic Armageddon of 2008.
But this is not the story of two Cassandras and their unheeded cry that Wall Street’s bubble was about to burst. Instead, the Bloomberg/Schumer report focused on a very different danger: the risk that London, or perhaps Hong Kong or Dubai, might soon eclipse New York as the world’s financial capital. Were that to happen, Schumer and Bloomberg warned in an op-ed published in the Wall Street Journal on November 1, 2006, foreshadowing the full report, “this would be devastating for both our city and nation.”
To avert such disaster, Schumer and Bloomberg counseled urgent action. The first problem to fix was the overly harsh regulation of Wall Street. As they wrote in their op-ed, “While our regulatory bodies are often competing to be the toughest cop on the street, the British regulatory body seems to be more collaborative and solutions-oriented.” The full McKinsey report, made public two months later, elaborated on this danger: “When asked to compare New York and London on regulatory attractiveness and responsiveness, both CEOs and other senior executives viewed New York as having a worse regulatory environment than London by a statistically significant margin.”
A specific risk posed by America’s overly strict financial regulators, McKinsey warned, was that their approach was driving the highly desirable derivatives business abroad. “Europe—and London in particular—is already ahead of the U.S. and New York in OTC [over the counter—which is to say difficult for regulators to monitor] derivatives, which drive broader trading flows and help foster the kind of continuous innovation that contributes heavily to financial services leadership,” the McKinsey report cautioned. “‘The U.S. is running the risk of being marginalized’ in derivatives, to quote one business leader, because of its business climate, not its location. The more amenable and collaborative regulatory environment in London in particular makes businesses more comfortable about creating new derivative products and structures there than in the U.S.”
Moreover, the report sounded an alarm about the future. America’s overly zealous regulators were on the verge of another colossal mistake: they were planning to raise capital requirements for U.S. banks, a measure McKinsey warned was unnecessary and would weaken the country’s financial champions in the fierce global competition for business. “U.S. banking regulators have proposed changes that would result in U.S. banks holding higher capital levels than their non-U.S. peers, which could put them at a competitive disadvantage,” the study said. These tougher new requirements were unnecessary, in McKinsey’s view. Instead, the report advocated a more sophisticated approach that took into account the economic environment. “This application also ignores some of the changes in capital requirements that occur as a result of economic cycles,” the report argued. “In a strong economic environment, for instance, capital requirements in a risk-based system should actually decline.”
Read with the benefit of hindsight, the Bloomberg/Schumer/McKinsey report is a parody of hubris. The overall concern with overly harsh U.S. regulators, a year before regulatory laxity permitted the worst financial crisis in three generations, is clearly absurd. The specific fears are even more specious. Alarm about a U.S. regulatory environment that was unduly restrictive of derivatives—those were the very financial instruments at the heart of the crisis. Worry that new capital requirements would be unnecessarily onerous—when it turns out that higher capital requirements were precisely what the banking system needed. Had Michael Moore set out to write a satire about the shortsighted greed of U.S. financial and political elites, he could not have invented better examples.
The arguments in the report are so wrong that it is easy to mock McKinsey, the author, and Bloomberg and Schumer, the sponsors. But what is really striking is how bipartisan and transatlantic the consensus within the Anglo-American financial and political elite was on the ideas in the study. Bloomberg is an independent; Schumer is a Democrat. Eliot Spitzer, the erstwhile sheriff of Wall Street as New York’s attorney general and then governor of New York State, joined Bloomberg and Schumer at the press conference announcing their report and broadly supported its conclusions. Two days before Bloomberg and Schumer took to the op-ed pages of the Wall Street Journal to raise the curtain on their report, another bipartisan pair, Glenn Hubbard, the dean of Columbia Business School, former Bush adviser, and future Mitt Romney adviser, and John Thornton, the active Democratic donor and former president of Goldman Sachs, announced that they, too, had organized a study on costly regulation and whether it was causing the U.S. capital markets to lose ground to foreign rivals.
Hank Paulson, the Republican Treasury secretary and former chairman and CEO of Goldman Sachs, traveled to New York a few weeks after these twin editorials to give a speech to the Economic Club of New York on “The Competitiveness of U.S. Capital Markets” in which he praised the Bloomberg/Schumer op-ed as being “right on target.” To make his point that Americans were in danger of overregulation, Paulson approvingly quoted a Democratic predecessor as secretary of the Treasury and fellow former Goldman Sachs chairman, Bob Rubin: “In a recent speech, former Treasury secretary Bob Rubin said this about regulation: ‘Our society seems to have an increased tendency to want to eliminate or minimize risk, instead of making cost/benefit judgments on risk reduction in order to achieve optimal balances.’”
A final U.S. contribution from the department of irony. A few weeks after the Schumer/Bloomberg op-ed had been published, one captain of finance wrote a letter to the editor to support their fight against “overregulation.” He was John Thain, then the CEO of the New York Stock Exchange. Two years later, Thain, by then CEO of Merrill Lynch, was forced to sell the nearly hundred-year-old firm to Bank of America at a fire sale price because of a financial crisis caused in great measure by inadequate regulation.
Across the ocean, the elite consensus was equally strong. A few days after the McKinsey study was released in New York, Sir Howard Davies, the director of the London School of Economics, former head of Britain’s top regulator, the Financial Services Authority, and former deputy governor of the Bank of England, opined, from the snowy slopes of Davos, that Bloomberg had “set a cat among the snow eagles this week.” The New York mayor, Sir Howard argued, was absolutely right: the American capital markets “are losing market share relentlessly against London.” The English peer’s fear was that in order to level the global playing field, the United States would try to impose its overly onerous regulatory approach on the rest of the world: “The Americans, as we know, are famously generous people, and they are even prepared to export their regulations, free of charge to the rest of the world.”
From Sir Howard’s perspective, the danger as viewed from Davos in 2007 was that the Republican administration of George W. Bush would seek to force the rest of the world to adopt America’s unnecessarily tough regulation of its financial sector. But Sir Howard held out the hope that Britain’s Labour government and its famously brainy economic duo of Prime Minister Gordon Brown and his Harvard- and Oxford-trained adviser, Edward Balls, would defend Great Britain’s superior “light-touch” regulatory approach against the Yanks. Sir Howard’s column is titled “Balls Must Save Us from U.S. Regulatory Creep.” Of Davos, he reports: “Gordon Brown patrolled the conference corridors, ready to explain that the London markets, like the NHS [the National Health Service], are safe in his hands. In this territory, he has a good story to tell.” (Incidentally for Sir Howard, the future embarrassment of having written this opinion piece would turn out to be a lesser example of the personal dangers of buying into the worldview of the global plutocracy. On March 3, 2011, he resigned as director of the LSE because of the embarrassment he had caused the school by accepting a £1.5 million donation from Saif Gadhafi, son of the dictator, and agreeing to a £2.2 million deal to train Libyan civil servants. Sir Howard had also been a paid adviser to Libya’s sovereign wealth fund.)
Once you get beyond how jarringly wrong all of these bold-faced names were, and how uniform, bipartisan, and international their consensus, you notice the epistemological wrong turn at the center of their mistake. The premise of this entire 2006–2007 conversation about the regulation of U.S. financial markets was that you learn whether your rules are working by asking the banks upon which they are imposed. Here’s how McKinsey described its methodology: “To bring a fresh perspective to this topic, a McKinsey team personally interviewed more than 50 financial services industry CEOs and business leaders. The team also captured the views of more than 30 other leading financial services CEOs through a survey and those of more than 275 additional global financial services senior executives through a separate on-line survey.” There’s a nod toward other points of view—“to balance this business perspective with that of other constituencies, the team interviewed numerous representatives of leading investor, labor, and consumer groups”—but it is a token effort compared to the meticulous attention focused on the bankers. And, like asking children whether they are satisfied with their bedtime, or surveying workers to find out whether they are paid enough, the results of the McKinsey investigation were entirely predictable.
The paradox, of course, is that these captains of finance were not only wrong about what was best for America—they were wrong about their own self-interest, too. I happened to interview John Thain on September 16, 2008, the day after he sold Merrill Lynch. On the Street, the deal itself was widely viewed as a masterstroke, particularly compared to Dick Fuld’s failure to find a buyer for Lehman Brothers a few weeks earlier. But Thain was anything but triumphant. We met in the Wall Street office whose $1.2 million redecoration would soon become infamous. I was blithely unaware of the million-dollar splendor of the furnishings, but I could see that Thain, who was normally precisely turned out and glowing with health, looked tired and discombobulated. “I totally understand why Dick Fuld couldn’t do it,” Thain told me when I asked him why he had been able to sell his bank but Fuld had not.
“This was a hard thing for me to do, and I’ve been here for eight months…. It is heart-wrenching. I totally understand why it was impossible for him. The emotional difficulty of selling your company is very great. It is really hard.”
The self-interested, and ultimately self-destructive, herd mentality on Wall Street and in the City of London shaped policy around the world, but it didn’t prevail everywhere. One exception was Canada. Canadian regulators required their banks to hold more capital and permitted less leverage than their peers in London and New York. The result was no bailout of the Canadian financial sector and a recession (and budget deficit) that were much softer than in the United States. To this day, the Bank of Canada divides the world into “crisis economies,” which means those whose banks failed, and everyone else, like Canada.
Ottawa chose a different course because the government had a profoundly different attitude about its duties toward the system as a whole and its relationship with its bankers. As minister of finance in the 1990s, Paul Martin laid the foundations for this approach. Martin is no hoi polloi class warrior—he’s a self-made multimillionaire. But, he told me, his priority in finance was: “I knew there was going to be a banking crisis at some point and so did everyone else who has read any history. I just wanted to be damn sure that when a crisis occurred it wouldn’t occur in Canada, and that if it did occur internationally, Canada’s banks wouldn’t be badly sideswiped by the contagion.”
Don Drummond, who later became the chief economist at TD Bank, was a senior official at the finance ministry in the 1990s. “The perspective of government on the financial sector is: ‘We are the regulator—our job is to tell you what to do, not to help you grow,’” he told me. “The government has always felt its job was to say no.” Thanks to this mind-set, Martin and his team had the self-confidence to opt out of what became the international contest to create the most attractive haven for global capital. Canada raised its capital requirements as they were lowered in other parts of the world.
“I think one of the things that happened was the great competition between New York and London pushed the two into more of a light touch in terms of regulation,” Martin recalled. “I remember talking to [the regulator] and we agreed that we were not prepared to take that approach. Light-touch regulation in an industry that was so dependent on liquidity didn’t make any sense.”
One Bay Street financier summed it up more saltily: “Canadian regulators didn’t have penis envy.”
With hindsight, that decision seems brilliant. At the time, though, to many it seemed, well, limp. One measure of how strongly the tide of world opinion was running against the Canucks is that the International Monetary Fund, meant to be the stern guardian of the global economy, chided Canada for not doing enough to promote securitization in its mortgage market—one of the American financial innovations that contributed to the crisis. Even communist China accused the Canadians of being too cautious about capitalism. Jim Flaherty, Canada’s finance minister, told me that on a visit to Beijing in 2007, “they were suggesting that maybe Canadian banks were too timid.”
Canada’s bright young things were sympathetic to this critique. One newspaper columnist liked to write about “the tale of two Royals,” comparing the stodgy Royal Bank of Canada to its buccaneering, world-beating Edinburgh cousin, the Royal Bank of Scotland. (The British government had to nationalize RBS in 2008 and spent billions to cover its loses; RBC in 2012 was one of the top twenty banks in the world, with a market capitalization of $74 billion.) A Canadian finance executive who spent the 1990s in Toronto, then moved to Asia, and now lives in London sheepishly recalls thinking: “Come on, guys, get in the game! The world’s changing.”
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 in another story: the rise of the super-elite. Much of the 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.
Wider 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 economists 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 from 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 economists 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. But in a trend Goldin and Katz also document, and which seems to have been intuitively understood in Harvard Yard twenty years ago, the same skills and experience deliver a super-return when deployed on Wall Street as compared to anywhere else in the economy. Philippon and Reshef call this the “finance wage premium” and estimate it at 30 percent to 40 percent.
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 has 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.”
One telltale sign the state is deciding who gets rich is how much time and money plutocrats spend on selecting their government and influencing its decisions. As before, the answer is hardly contrarian. But when IMF economists Deniz Igan, Prachi Mishra, and Thierry Tressel set out to document how powerful the influence of Wall Street was on Washington, their conclusion, framed in sober academic language, was as incendiary as any agitprop from the Tea Party or OWS. The killer fact was their finding that between 2000 and 2006 laws increasing regulation of the finance and real estate sectors had just a 5 percent chance of passing. Laws that deregulated were three times more likely to pass.
One Russian oligarch told me that a pleasant surprise for him during the privatizations of the 1990s was that you didn’t have to bribe many of the country’s most senior technocrats. “Well, of course, I wrote the law myself, and I took special care with it,” Konstantin Kagalovsky told me, still, a couple of years later, delighted at the power of ideas. That was also true in the first decade of this century in Washington: Igan and Mishra found, predictably, that more conservative politicians, who were ideologically broadly in favor of less regulation, were more likely to back legislation that loosened the rules.
But direct intervention played a key role, too. Igan and Mishra found that the finance and real estate sectors spent $2.2 billion lobbying Washington between 1999 and 2006, reaching a peak of $720 million in the 2005–2006 period. In keeping with the sector’s relatively increasing weight within the super-elite overall, its lobbying spending grew faster than that of business generally, and accounted for more than 15 percent of all lobbying spending in D.C. by 2006. Good news for Wall Street’s government relations officers—their money worked: “Lobbying expenditures by the affected financial firms were significantly associated with how politicians voted on the key bills.”
What’s especially important about this study is that it documents the relationship between Wall Street and Washington before the 2008 financial crisis and subsequent multitrillion-dollar bailout. That rescue is what prompted populist anger on both right and left and claims, as Sarah Palin put it in an op-ed in the Wall Street Journal, that Washington had occupied Wall Street. But the real government capture actually happened in the three decades before 2008, with the long, steady, bipartisan rollout of financial deregulation.
Dani Kaufmann grew up in Chile. He was studying at Hebrew University when Pinochet seized power in a coup in 1973, and elected not to return, ending up instead at Harvard, where he eventually earned a PhD in economics. His next stop was the World Bank, where he worked on Africa and then, after the collapse of the Soviet Union, the transition to capitalism in what used to be the Warsaw Pact states. By the time Kaufmann returned to World Bank headquarters in Washington, he knew that his life’s project would be to study corruption and its opposite, good governance, two themes he knew well from his work in Africa and the former Soviet Union, and viscerally from his Latin American roots.
But as Kaufmann looked further into rent-seeking around the world, the ways that it slowed economic development, and how it could be stopped, he discovered something that surprised him. The naked forms of corruption that development organizations and NGOs agonized over most—bribes demanded by government officials with coercive power, like policemen, or required for ordinary state services, like teaching, or even despots extracting their nation’s wealth and sending it to numbered Swiss bank accounts—were only part of the story.
About $1 trillion, by Kaufmann’s estimate, was paid in outright bribes around the world every year. But orders of magnitude more money was being made thanks to what he dubbed “legal corruption”: “The cost to society of bribing a bureaucrat to obtain a permit to operate a small firm pales in comparison with, say, a telecommunications conglomerate that corrupts a politician to shape the rules of the game granting it monopolistic rights, or an investment bank influencing the regulatory and oversight regime governing it.”
As he developed the idea, Kaufmann started to try to measure it. One idea he had was to ask global business leaders themselves, as identified by the World Economic Forum, to rate levels of both explicit corruption, such as bribery, and legal corruption, like campaign contributions and lobbying, in 104 countries. The results confirmed his hunch, especially when it came to the United States. Predictably, the United States was ranked one of the least nakedly corrupt countries in the survey, coming in at twenty-five, just below Canada and well above countries like Italy, Spain, and South Korea. But when it came to legal corruption, the business leaders put the United States at fifty-three, squarely in the middle of the global pack, and worryingly close to countries like Russia, in position seventy-four, and India, at seventy.
Suggestively, the countries where the surge in income at the very top has been most marked—the United States, the United Kingdom, and fast-growing emerging markets like Russia, India, and China—also rank relatively high in Kaufmann’s legal corruption table. That connection is most marked when you compare the high-inequality countries with nations with comparable levels of GDP but less inequality. In most such pairs—Norway or the Netherlands compared to the United States or United Kingdom, for instance; or Estonia compared to Russia—less legal corruption goes along with a smaller gap between the 1 percent and everyone else.
No one openly champions “legal corruption” as a good way to run a country, but one reason it is harder to denounce than it seems is that many of the reforms that enable legal corruption were actually intended to make economies more transparent, more fair, and more effective. That is true of the privatization drives that sometimes devolved into giveaways, and it is true of deregulation efforts in areas like finance or telecommunications. Liberalization doesn’t have to be legally corrupt, but because it is often about opening vast new economic opportunities, it can easily become so, especially if governance is weak.
That’s why what looks, from the outside, as if it must be a nakedly corrupt decision—for instance, the Telmex privatization or Russia’s loans for shares—is at least sometimes the work of reasonably honest and genuinely well-intentioned market reformers. That was true, astonishingly, of Russian reforms at the outset and it is certainly true of financial deregulation.
But legal corruption gets more complicated and more compromising once you start dividing the spoils. Eventually the material gap between the true-believing technocrats and the businessmen their reforms enrich becomes an obstacle and a temptation for even the most upright civil servant. The widening financial divide becomes even harder to tolerate as the reformers realize that the wealth their programs transferred has made the beneficiaries not only rich, but politically powerful, too. It was this heartbreaking epiphany that corrupted many of the Russian reformers and persuaded them to try to make themselves into oligarchs. Those who didn’t often regretted it. The Western-educated wife of a former Soviet leader who took significant personal risks to enact his reform plan told me, as her husband was leaving office, “I could have charged $100,000 for one-hour meetings with my husband. Now I wish I had.” Her plan, she hastened to add, would of course have been to donate all the money to her charitable foundation.
In Western countries with significant legal corruption, that financial gulf creates a revolving door between the regulators and the regulated. One study of the SEC found that, between 2006 and 2010, 219 former SEC employees had filed almost eight hundred disclosure statements for representing their new clients’ dealings with the agency, their former employer. Nearly half of these disclosures were filed by people who had worked at the sharp end of the SEC’s relationship with business, in its enforcement division.
It is easy to understand the appeal of switching from gamekeeper to poacher—in 1980, the top regulators earned one-tenth the incomes of the leaders of the businesses they policed; by 2005 the ratio had jumped to one-sixtieth. Moreover, if the revolving door were locked, the gamekeepers might be even weaker. Given the income gap, how many members of the Harvard class of 2012 will choose government service, especially if there is no opportunity to switch to a more lucrative private sector role later on? And at a time of increasing economic complexity, what chance does government have of keeping up with business if the best and the brightest go to the private sector?
Finally, the age of globalization has brought one more twist to the story of rent-seeking and how it has helped to create the super-elite: like so much else, rent-seeking has now gone global. That’s not entirely a new story—multinationals have long paid bribes to secure contracts abroad, and some of the most lucrative examples of historic rent-seeking have involved overseas concessions, like the East India Company’s right to trade in India granted by the British Crown, or the Hudson’s Bay Company’s rights to the Canadian fur trade.
But the international ripple effect of rent-seeking is today even more extensive. A fortune created by rent-seeking in one country can have a powerful effect thousands of miles away. Britain’s football clubs and, increasingly, its newspapers are being bought up by emerging markets oligarchs, particularly Russians. Between 2008 and 2011 the second-largest shareholder in the New York Times was Carlos Slim.
Even rent-seeking plutocrats who’ve made their fortunes the old-fashioned way—by being authoritarian despots—have been cheerfully courted by the global plutocracy. That was the case with Saif Gadhafi, who, just two years before protesters bloodily overthrew his father’s four-decade-long dictatorship, was courted by a private equity tycoon over Saturday lunch in his magnificent home on Park Avenue and gave speeches at Davos and at the Council on Foreign Relations. The London School of Economics accepted a £1.5 million gift from the Gadhafi family and awarded Saif a degree; the Monitor Group, one of the most respected and internationally minded consultancies, became a paid adviser to the regime for a yearly fee that reached a yearly peak of $3 million.
Legal corruption is going global, too. The threat that business, particularly finance, might move to another country was one of the most powerful arguments in favor of deregulation, especially before 2008. Witness, for example, the 2007 McKinsey/Bloomberg/Schumer report prepared by McKinsey for Michael Bloomberg on the threat that other, less onerously regulated financial centers, particularly London, posed to New York’s pole position as the world’s preeminent financial capital. One of the key recommendations was that the United States shift to the British “light touch” regulatory philosophy.
As rent-seeking wealth spills across borders from the country where it was granted to other parts of the world, as rent-seeking plutocrats do deals with one another, and as economic rules go global, the question Professor Rajan asked of the Bombay Chamber of Commerce may need to be adjusted. He asked his Indian audience if their country was at risk of political capture by rent-seeking national oligarchs. An equal, and probably greater, danger is the rise of an international rent-seeking global oligarchy.