Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else (36 page)

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.”

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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.

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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.

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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.