Return of the Robber Barons

Can we tell “makers” from “takers” among the new super-rich?

Thomas Jefferson took pride in the egalitarianism of the fledgling American Republic he helped create, as opposed to the class stratification of English society. “The great mass of our population is of laborers; our rich, who can live without labor, either manual or professional, being few, and of moderate wealth … Can any condition of society be more desirable than this?” By the end of the 19th century, with the industrialization of the United States and the rise of the so-called robber barons, that romantic egalitarianism, if it ever truly existed, was long gone.

In Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else, Chrystia Freeland offers a detailed account of the contemporary rise of plutocrats (defined as the super-rich or 1 percent of the 1 percent) and the dangerous prospect of their emerging power in the United States and elsewhere: among the Russian oligarchs, of course, and, just as notably, among the powerful “princelings” of China. But the U.S. deserves a central role in this global analysis, because it seems to be leading the way in creating a democratic society based on wealth and access to political influence. We need look no further than the creation of the super PACs (political action committees) to see the American contribution to this dangerous trend.

Freeland demonstrates that vast wealth is being accumulated in fewer and fewer individual hands at the apex of the wealth pyramid. More significantly, within that apex, among the rarified 0.01 percent at the very top, wealth accumulation is accelerating at an unprecedented rate, far outstripping that occurring among the merely rich with less than $50 million in assets.

I read this book with mixed feelings of admiration for some plutocrats, disdain for others, anger at the potential collapse of the American dream, a little envy, and concern for the future of healthy capitalism, as we watch the widening chasm between the top 0.01 percent and the rest of society, particularly in the United States.

A story as lurid as this requires villains, and Freeland lets us consider three groups. First, there are the oligarchs who virtually stole the assets of the Russian people through loans-for-shares privatization. The author does not dwell overlong on this cohort of skillful predators, given the attention she gave to its lightning rise in her previous book, Sale of the Century: Russia’s Wild Ride from Communism to Capitalism. Suffice it to say that by 1998, after less than a decade of capitalism, just seven men controlled half the Russian economy—oligarchs such as oil, banking and telecom magnate Mikhail Fridman, metals and oil mogul Viktor Vekselberg, and metal and banking baron Vladimir Potanin.

Second, there are the Wall Street financiers whose incomes continue to greatly outstrip other professions despite their culpability for one of the worst financial crises in history. Listen to former labour secretary Robert Reich from a blog posting in October 2012 on the aftermath of the 2008 crash: “Most of us lost big … But the top 1 percent have done just fine. In the first year of the recovery they reaped 93 percent of the gains. The latest data show them back with 20 to 25 percent of the nation’s total income—just where they were in 2007.”

Freeland cites one study that Harvard graduates who went into banking earn 195 percent more than their classmates who chose other professions and pinpoints the case of Chuck Prince, then CEO of Citigroup, who was forced to leave his corner office after the bank suffered gargantuan losses in 2008 and was the object of a huge government bailout. She opines that “Prince deserved his pink slip,” but neglects to mention that his severance package was worth many millions, including an exit bonus of $12.5 million.

Third, there are the top-paid executives of corporate America. According to the AFL-CIO’s Executive PayWatch, in 1980 the CEO pay at large American corporations equalled 42 times the average blue-collar worker. In 2010, that multiplier had increased to 343 times.

A good deal of Freeland’s book sets out to show how such phenomenal inequality has occurred in this third group. She finds the answer in a comment by former General Electric CEO Jack Welch, who allegedly said what the chief executive needs is “a generous compensation committee.”

These compensation committees, staffed by other corporate executives, create mutual appreciation societies that have ratcheted CEO compensation far beyond reasonable limits. Freeland rightly points out that boards of directors where ownership is widely dispersed “lack the time, expertise, and gumption to weigh in on the specifics of how companies operate” and tend to operate on the principle of collaborative back-scratching.

The Organisation for Economic Co-operation and Development tackled this issue in its OECD Principles of Corporate Governance issued in 1999 by a high-level group of experts co-chaired by Sir Adrian Cadbury and Ira Millstein:

It is considered good practice in an increasing number of countries that remuneration policy and employment contracts for board members and key executives be handled by a special committee of the board comprising either wholly or a majority of independent directors. There are also calls for a remuneration committee that excludes executives that serve on each others’ remuneration committees, which could lead to conflicts of interest.

It seems clear that such good practice has yet to find fertile ground upon which to grow and flourish.

Freeland highlights the gaping differences between plutocrats and the rest of us. To put the rapidly increasing income disparities in the United States in perspective, she cites a study showing that in 2008 the top 0.01 percent of families averaged $24 million while the bottom 90 percent made about $30,000.

Surely, Freeland implies, this rapidly increasing wealth and income gap in the U.S. is unsustainable and likely to undermine the commitment of the lower 90 percent to current U.S. capitalism. How long will it be before we see attempts to replace it with a more populist system, more state intervention and, ultimately, a social democratic republic?

We have seen this before.

The growing concentration of wealth in the United States in the early 20th century was of great concern.

But following the Great Depression there was a major readjustment and a move away from a possible plutocracy controlled by those whom Roosevelt called economic royalists. Freeland’s work, replete with reams of statistics, illustrates this in the case of bankers with a revealing U curve: bankers were highly remunerated until about 1930. Then remuneration declined and they found themselves among normal corporate executives. But beginning around 1980, incomes of bankers rose at an astonishing rate, recovering in relative terms to the level of the 1930s.

Freeland echoes the view of economists at the International Monetary Fund who put this down to deregulation—in particular the tight relationship between Wall Street and Washington and the inexorable pressure the former brought to bear on the latter as the 20th century progressed. Success for the deregulators came in 1999 when the Glass-Steagall Act, intended to separate banking and securities activities, was repealed.

Arguably, deregulation in turn accelerated the replacement in the traditional conservative and somewhat staid banking sector with Harvard men, a new breed of investment bankers with access to other people’s money. It all changed, and not for the better.

Plutocrats gives a detailed description of the rise of the super-rich. Freeland includes a fairly sharp piece of social commentary when she points to the financial benefits of the many who surf the wake of the wealthy, such as the army of professional superstars including doctors, dentists, chefs, lawyers, interior decorators, architects and entertainers, among others. But the book is not simply a diatribe against the wealthy and successful in our globalized society, notwithstanding the line in the subtitle “and the fall of everyone else.”

For example, Freeland references the experience in emerging markets, especially in the emerging world’s two economic powerhouses. “In India and China,” she notes, “the past three decades of  freer markets have lifted hundreds of millions of people out of poverty, a feat the previous three decades of left-leaning development economics had singularly failed to accomplish.”

So “the fall of everyone else” may not be a fair description. Globalization has created winners and losers but, as Freeland’s interviews suggest, the world as a whole is richer because of it. Unfortunately, that wealth has not been equitably distributed, especially to the detriment of the middle class workers in the western industrialized countries. The hollowing out of the middle class and the concomitant loss of manufacturing jobs has been a major challenge, exploited by every American politician who uses China as a scapegoat.

But politicians tend to ignore the impact of technology such as robotics in American job losses. One could also add the failure in much of the western world to consider the education deficit, which has made it hard for laid-off workers to adapt, as the Japanese did much more successfully when much of their manufacturing suffered the same fate thanks to Korea and, latterly, China.

In this context, I was greatly troubled by a quotation the author attributes to a Greenwich-based hedge fund manager, undoubtedly one of the super-rich, who opines that “the low-skilled American worker is the most overpaid worker in the world.”

Another Taiwanese-born capitalist is quoted as saying: “So, if you’re going to demand ten times the paycheck than the rest of the world, you need to deliver ten times the value. It sounds harsh, but maybe people in the middle class need to decide to take a pay cut.”

This widespread insensitivity of the rich, who have protected themselves against the economic hardships suffered by the lower 90 percent, is discouraging, and does not portend well for long-term social stability. It is extremely short-sighted and incompatible with the America that much of the world has come to admire and wishes to replicate.

The answer does not lie in invoking protectionist policies of the past. Globalization, as Freeland suggests, is irreversible. Rather, it lies in adjustment policies, which means a much better educated workforce, and social protection for those too old to adjust and recycle themselves into other decent-paying job opportunities. But this is a costly project, and the abhorrence of the rich for paying taxes makes this a serious challenge, especially in the United States. Freeland touches on all these points and properly lays great emphasis on quality education.

Throughout the book there are interviews with successful entrepreneurs, captains of industry and economists, many of whom are household names, especially to readers with international experience. Freeland also taps into a new and younger generation of economists who have done, and are doing, some pioneering work in the area.

On the question of who is responsible for the fraught landscape she is describing, she offers this comment from Google’s Eric Schmidt: “I think it’s very important to distinguish between rich people who get there by taking the economic rents of the country for their own benefit versus the people who, in fact, create a new corporation or a new source of wealth.”

Freeland seems to think that the difference is not as great as Schmidt suggests. She writes: “Economic elites … are driven by the same imperative to make money and win competitive advantage for themselves and their companies … The difference isn’t between having virtuous and villainous business people, it is about whether your society has the right rules and policing able to enforce them.”

I am less certain. In fact, I am uncomfortable with two conclusions that Freeland draws from her wealth of detailed research and interviews.

First, I agree with Schmidt. We should value wealth creators over economic parasites such as Russian oligarchs, financiers who engage in unethical (although not necessarily illegal) practices and overcompensated corporate bureaucrats. What sources of new wealth have these groups created with their own risk capital? Have they not simply profited unduly from the capital and creativity of others who have actually produced goods, services and jobs, and taken risks for minimal returns?

Second, I am uneasy with Freeland’s apparent inclination toward regulation, revealed when she (properly) assails a McKinsey study, commissioned by New York mayor Michael Bloomberg and Senator Chuck Schumer just prior to the financial meltdown, which argued that more regulation would result in New York’s decline and the City of London’s ascension. Freeland characterizes the study as a “parody of hubris.”

Obviously, in hindsight, she is correct. But when she says that we need “the right rules and policing able to enforce them,” I disagree.

Is there not a better approach than more burdensome regulation such as the Sarbanes-Oxley or Dodd-Frank acts? Might this not be an opportune time to revert to principles—principles from which rules must flow, but only as examples?

These are debatable issues to be sure, and turn in particular on the extent to which regulatory bodies and courts can be given discretion to determine whether a principle has been breached. (I would argue that they can.) But I believe that regulatory overkill in response to public outrage, which resulted in both of the aforementioned acts, can kill the goose that lays the golden eggs, namely, a well-functioning and creative open market economy.

For example, when rules are imposed, many find it legitimate to seek ways around the rules. We saw this with the tactic employed by Lehman Brothers, investigated by bank examiner Anton Valukas, who reported how Lehman executives manipulated their balance sheet through an accounting manoeuvre known as “Repo 105” that allowed them to hide the company’s parlous financial condition. It would seem that, armed with a legal opinion, the perpetrators of this scheme found comfort in its legality. It may have been legal, but it was not right, and was obviously unethical.

Had a principle been invoked instead of a rule, perhaps this would not have taken place. For example, one can think of at least two principles that might govern the behaviour of management in such circumstances: the principle of transparency and the fiduciary principle that should require management to act in the best interests of shareholders and other stakeholders such as creditors and employees.

As we go forward from the financial wreckage of the past several years, I hope our systems will rely on and apply principles more than rules that the unscrupulous can wriggle around. Even the most talented of the legal profession, handsomely rewarded for such wriggling, cannot ignore governing principles.

With those personal reservations, I believe Chrystia Freeland has produced a very thorough and thought-provoking book covering a vast range of subjects and issues. They will long be debated in the wake of the extraordinary financial train wreck of our era.