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THE CAPITALISM THEY HATE * - Anthony de Jasay, Political Economy, Concisely 
Political Economy, Concisely: Essays on Policy that does not work and Markets that do. Edited and with an Introduction by Hartmut Kliemt (Indianapolis: Liberty Fund, 2009).
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THE CAPITALISM THEY HATE*
THE INEQUALITY MACHINE
Freedom of contract is inexorably followed by streams of voluntary exchanges and a widening division of labor. Individual ownership of the goods exchanged and of the factors that produce them completes the necessary conditions of the capitalist system. It is easy to grasp that this system must ceaselessly generate unequal distributions of income and wealth and also that these distributions will not settle down to any particular durable pattern.
Unequal distributions spring from two sources. One is inequality of endowments, inherited or acquired. Talent, force of character, strength of will, industry, and thrift may be genetically implanted or learned; knowledge, a “network” of friends, acquaintances, and patrons, and command over capital and credit may be inherited or acquired. Some of these differential endowments can in principle be destroyed or leveled out by forcible collective action. Capital, for one, may be confiscated and held in “social ownership” or redistributed equally. Knowledge may be more equally spread by setting up a universal and “anti-elitist” educational apparatus. Most endowments, however, cannot be eliminated or equalized and will inevitably produce unequal incomes and possessions. However, even if in some utopia all individual endowments could, by clever legal, fiscal, educational, and technical devices, be flattened out, there would still remain one generator of inequality, probably the most powerful of all, namely luck. It is by definition random; it rides roughshod over government policies as well as over personal merit and desert. If nothing else made for inequality, luck alone would suffice to keep the great Inequality Machine of capitalism churning out a kaleidoscopic pattern of incomes and wealth, in which any advantage gained would provide means for further advantage, helping the rich to become richer.
Dislike of inequality may have many motives. Some ascribe it to the genetic heritage of humanoids and preagriculture humans, for whom equal sharing may have been a good survival strategy for one’s genes—though it has become an obsolete and inferior strategy since man has learned to grow and store food for himself and his family. Others, plausibly enough, trace the roots of egalitarianism to plain envy. Be that as it may, the expectation of gain from the flattening out of the distribution would always serve as an egalitarian incentive for all with below-the-mean income or wealth. However, none of these motives is really avowable; none sounds unselfish or noble enough.
Charitably screening any such naked opportunism from open view, educated opinion has put up the moral imperative of “social justice,” whose runaway success in academic and other intellectual circles in the last half century is a sad illustration of how easily gaseous concepts and pompous jargon overcome straightforward logic. Instead of saying that many desire equality for a variety of more or less respectable reasons, we must now say that inequality is unjust—a very different proposition.
(A little thought reveals an awkward feature of “social justice theory.” If, by some miracle, complete equality were once brought about, social justice would still not be satisfied, for it can never be. It would at that point require the creation of new income inequalities in order to achieve equality of some other welfare criterion, e.g., utility levels. However, since nobody knows or can ever discover anybody’s utility level, to affirm that they are now equal is no more valid than to affirm that further income inequalities are required to make them equal. Any distribution could be found unjust on some ground and such a finding would be no less valid than any other. This insight highlights one of the pathetic infirmities of social justice, namely that it has no rules by which a socially just state of affairs could ever be identified. Trying vainly to capture it, the foolish carousel can keep going round and round forever.)
At all events, thanks to social justice “theory,” capitalism as the great Inequality Machine, stands guilty of spreading injustice all over the social landscape. From 1917 to 1989, the social and economic disaster that was the Soviet empire served as the great excuse that made most sober-minded people forgive capitalism’s sins. Capitalism delivered the goods, and socialism did not. This was very nearly a knockdown argument. Attempts at building social-democratic halfway houses in which one can have it both ways have had indifferent success. As the dynamics of the welfare state are coming to be better understood, these attempts carry less and less conviction. Yet, as the hopelessness of “real existing” socialism fades from immediate memory, and as it is being taken quite blithely for granted that no matter what, capitalism will always deliver the goods whether we prize or blame it, opinion toward it is becoming less forgiving.
“Globalization,” or rather its great acceleration in recent decades, has made forgiveness harder to grant. If the world economy were made up of many well-insulated compartments, the Inequality Machine would soon neutralize itself by starting to work in two opposing ways. Once capitalism took hold and the rate of capital accumulation exceeded the rate of growth of the active population, the rich would no longer become richer as the poor became poorer. Instead, with the supply of labor expanding less fast than the demand for it, both the rich and the poor would become richer, but the poor would become richer a bit faster, offsetting some of the extra inequality resulting from the rich having more capital working for them. The net effect would depend on the actual numbers and on the pace of technological change, but it is a fair conjecture that no Marxian “iron law” would rule the scene.
When, however, the compartments open up, this equilibrating effect may be much retarded. Goods are generally distant from where they are most wanted (or effectively employed), namely distant in time and in space. The distance in time may be overcome by borrowing from the future, and the cost of doing so is shown in the spectrum of interest rates augmented by some risk premium attaching to the borrowing. Today’s moderate interest rates and more particularly the unusually low risk premiums reduce the cost of overcoming distance in time, and make the economy more open to a wider range of choices. Distance in space is overcome by incurring transport costs and the communications costs of sending instructions and making payments.
To judge by the persistent widening of the range of tradable goods and of long-distance trade, the development of transport technology and communications may have been faster than the technology of production, and this development seems recently to have accelerated. The shrinking of time and space probably accounts for the greater part of “globalization,” dwarfing the effect of lower tariffs and weaker nontariff barriers to trade.
Quickening globalization in recent decades has impacted inequality in the developed economies of the Western world in two ways. The return on capital has increased and so has the share of capital in national income. Concurrently, the rate of increase in the real wages of the semiskilled and the unskilled has slowed down or, in some areas, stopped altogether. The joint effect accounts for the widely voiced impression that the rich are getting richer and the poor poorer, though the latter part of the diagnosis is not really correct. The impression is in any case strong enough to condemn severely the Inequality Machine for sacrificing the middle and lower working classes on the altar of free trade, and to lend urgency to demands for protection of all kinds.
Some defenders of globalization argue that it is not the opening up of economic compartments that causes the unskilled and semiskilled to be left behind, but labor-saving technological progress. Even admitting that technological change is nearly always labor-saving and hardly ever capital-saving, its supposed effect on the supply-demand balance in the labor market is conjectural. It can lead to the conjecture that a run of labor-saving innovations could push the level of wages crashing down unless generous unemployment pay is offered to those who will not work for lower wages. However, recent economic history suggests that chronic unemployment is more typical of welfare states obsessed with social justice than of countries where labor-saving information technology has made the fastest progress.
The most plausible explanation of stagnating or slowly rising wages in the Western world is that globalization is indeed the culprit. The elasticity of supply of labor in Western economies has been drastically increased by the addition to their labor force of hundreds of millions of Chinese, Indian, and Indonesian workers who have for practical purposes become part of the Western labor market due to the vastly reduced cost of bringing their output to Western product markets. There is, as yet, no matching increase in the supply of capital, even though its accumulation has accelerated somewhat. Elementary reasoning leads one to expect that income distribution in the West will tilt in favor of capital. The facts bear out this expectation. The Inequality Machine of capitalism is guilty as charged.
What this judgment conveniently fails to notice is that globalization is global. Income distribution is changing not only in Western Europe and North America in the wake of shrinking transport and communications costs, but also in China, India, and Indonesia. Third-world employment is expanding rapidly, labor is migrating from the subsistence to the market economy, and its wages, starting from an abysmal level, are catching up with first-world levels at a double-digit annual rate. The factor price equalization theorem is hard at work thanks to the fusion of insulated compartments into an open world economy. Here, the Inequality Machine is producing more equality on a colossal scale by lifting the Eastern very poor to near the level of the Western poor. Nothing else, no development program, no “war on poverty,” no humanitarian campaign is in sight that would be remotely capable of doing the job. The envious and the morally indignant may hate capitalism for making the rich richer, but would they rather have the very poor remain very poor?
At the end of 2006, a year of which the financial services industry had little reason to complain, the head of Wall Street’s most prominent investment bank was rewarded with a bonus of $40 million. Some less prominent houses gave their heads bonuses ranging from $20 to $50 million. Very successful security or commodity traders were given twice or thrice the bonus of their own chief executives.
Promoter-managers of what are, in most cases quite misleadingly, called “hedge funds” (for few of them really hedge anything) who take 1 percent off the bottom year in, year out and 20 percent of gains off the top had no reason to complain either. Their investors ran greater-than-average risks, but most of them were fairly well rewarded by the 80 percent of the gains going to them. The managers took no risk and their 20 percent share made some of them a very large fortune in a single year.
Some top corporate executives, in fact employees of the shareholders, received compensations in the low to middle eight figures for loss of office, in addition to their pensions, when asked to make room for someone else. Golden handshakes were 24-karat, often awarded by board committees whose members were acting by the Kantian rule: Do as you would be done by.
Promoters of private equity funds, unlike directors of publicly held corporations, have great freedom to operate with borrowed capital and are indeed encouraged by their investors to run high risks by using high leverage. By good judgment and good luck, they usually succeed in making astronomical fortunes for themselves while their investors are adequately but not indecently rewarded for carrying most of the risk.
Part of the public in the United States, and a tiny handful in Europe, contemplates these spectacular earnings with admiring awe. Everyone else considers them indecent. They provoke the most virulent kind of hatred for capitalism.
The reason is not so much the vastness of the sums involved and the glaring inequalities they create, as the great ease with which they seem to come and the perversity of the value system they are supposed to reflect (though there is no reason to suppose that they reflect anything like a value system). Glaring inequalities are as old as history, and though they were occasionally rebelled against, they were not really perceived as indecent, esthetically disgusting, and morally reprehensible. All ancient empires were extremely inegalitarian. The states of ancient Greece appear to have been fairly egalitarian with the king perhaps ten times richer than the shepherd or the fisherman, but in ancient Rome the wealth and income of a rich senator must have been thousands of times greater than that of the proletarian plebs, let alone his outdoor slaves. Many of these differences were a matter of hierarchical status and were part of the tacitly accepted established order of things. There is no compelling reason why some of capitalism’s inherent inequalities should not in the fullness of time also be so accepted or (more probably) grudgingly acquiesced in, though the reasoning spirit of enlightenment will want to understand why the established capitalist order deserves at least tacit acceptance.
The same forbearance would be much harder to obtain for the inequalities due to “indecent” earnings. One obstacle in the way of their social acceptance is that they accrue to upstarts, fast-talking, fast-moving smoothies who have had too easy a ride to the top. They are too unlike the Dick Whittingtons and the legendary shoeshine boys who overcame adversity and rose by hard work and harder thrift.
But a possibly deeper reason is that there is little or nothing in the “indecent” multimillionaires that strikes the observer as truly entrepreneurial. They do not invent and do not make things that the market might either accept with pleasure or reject with indifference. They take few or no risks, but are parasitic on the risks taken by their investors and clients. Many of them are pure intermediaries, a function whose contribution to the economy is seldom appreciated by the wider public. Others, typically executive board members of large corporations, appear to be abusing the principal-agent relation, and though they do serve their principals, the shareholders, with moderate zeal, they serve first and above all themselves. Paying them with stock options is designed to attenuate the principal-agent problem (and it does resolve it to some extent), but is on the contrary suspected of being a corrupt practice fixed up by crony directors who expect to be similarly fixed up in return.
Most of us react to the decency or otherwise of large incomes and quickly made fortunes by moral reflexes that evolved under the capitalism of a generation or two ago. They have not yet been adjusted to the changes capitalism has since undergone. One such change is the flood tide of pension funds in the Anglo-American type of capitalism which, after all, sets the mode of operation the rest of the world is beginning to imitate. The needs of pension funds and the competition between their managers sets the maximization of asset values as the primary goal, and the more classic goal of profit maximization by corporate enterprise tends to become a mere instrument of the primary goal. Socialists whose rejection of the “system” is visceral rather than intellectual call this “casino capitalism,” run by and for “speculators.”
An even more far-reaching change is the great increase of financial relative to nonfinancial capital in private ownership. This is no doubt due to ever greater intermediation, which in turn is a by-product of the splitting up of risks and the distribution of different types of risk-bearing instruments among those most willing to carry each particular type. One result is the availability of immense pools of financial capital demanding what by historical standards looks little in the way of risk premium.
How all this leads to “indecent earnings” is clear enough. Corporate assets are now very mobile. They are readily hived off or reassembled. Whole corporations merged with others at the drop of a hat with or without the intervention of private equity firms, often spurred on by advisers eager for commissions. On the whole, this is probably a good thing, as it makes it much easier to redeploy assets from less to more productive uses than was the case only a couple of decades ago. Today, a $2-3 billion merger or acquisition hardly makes the financial columns of the press, and a deal must exceed $20 billion to make real news. Consider a $20 billion deal. The principals on either side are probably prepared to pay some fraction of the deal’s value to make doubly and trebly sure that there is no hitch, that nothing has been overlooked, that regulatory problems have been duly considered, and there is no flaw in the documentation. One percent of this deal would be $200 million. In fact, the teams of bankers and the batteries of lawyers will between them probably share a 0.5 percent fee—an absurdly high sum that is absurdly low relative to what an avoidable mistake or a derailed transaction would cost. Competition should keep the fees down, but the need for the advisers to have prestigious names will keep them up.
The outrage roused in the public by such sums being thrown around may stir politicians to action against “indecent” earnings. Capitalism would presumably be less hated, and more assured of survival under majoritarian voting, if such earnings could be outlawed or otherwise wished away. On mature reflection, however, any legislative or regulatory remedy is likely to prove worse than the disease, ultimately leading to evasion, corruption, immobility, and an ever-lengthening series of further measures to correct the perverse effects of their predecessors. The experience made with the Sarbanes-Oxley legislation in a somewhat different domain should serve as a lesson before it is decided to let politics deal with indecent earnings.
The least bad remedy is still to leave it well alone. It is a remedy that, for all its homeopathic modesty, has a shining virtue. Experience shows that people who have made indecently large incomes sooner or later seek to earn the esteem of their fellow men by making correspondingly vast donations to good causes. If anyone is ill tempered and ill informed enough to think that Warren Buffett’s gains are indecent, he should be told that the gentleman in question has recently donated $35 billion to charity. All big earners are not like him, but even the most unpleasant characters tend to end up doing the right thing in their testaments, if not sooner. Society has ways of exerting gentle but persistent pressure on the new rich to do good after they have done well and yet leaves them with the satisfaction and good conscience that voluntary benefaction affords them. It is surely best to leave things at that and not wreck the chances of the world’s poor by trying to make the very rich less rich.
[* ]First published as part 1, “The Inequality Machine,” and part 2, “Indecent Earnings,” of “The Capitalism They Hate,” by Liberty Fund, Inc., at www.econlib.org on February 5, 2007, and March 5, 2007. Reprinted by permission.