Summary:
Socialist countries like India have always looked upon wealth with suspicion. After the liberalization of the economy in 1991, the pursuit of wealth for its own sake became glamorous again in India as well as in other countries. The implosion of Communism and failure of Socialism across the world meant a general acceptance that Capitalism was the only game in town (even though some countries like Cuba gamely held onto Communism much longer). As the self-proclaimed leader of the Capitalist world, US did a lap of honor with the end of Cold War, marked by triumphalism as evidenced in articles like Francis Fukuyama's 'The End of History'. With time, the success of Capitalism has provided a serious boost to wealthy people by allowing them to capture most (if not all) of its benefits across the globe. With its opponents discredited, any constraining factors that would smooth out the rough edges of Capitalism (Workers' rights, Business Regulation, Income redistribution etc.,.) have been slowly and methodically rolled back. This book talks about the winners (in both developed and developing countries), who took advantage of the shift to Capitalism and raced ahead in wealth creation. The predictable effect has been widening income inequality within and across countries. Americans' illusions about American Dream has blinded them to the sobering reality that not everyone can become rich irrespective of their station in life. The succession of severe political aftershocks after the 2008 recession (Brexit, Donald Trump getting elected as US President) has to do with very real frustrations of people in developed economies who are coming to the (belated) realization that the rosy future sold to them was a worthless bill of goods. The trust people had in the political and economic elite prior to 2008 recession has been replaced by an insecurity and acknowledgement that what they bought into earlier (a prosperous and bright future) was no longer attainable for their children and grandchildren. The economic recovery from the 2008 recession has been uneven - for 99% of the Americans, incomes rose by 0.2% whereas it rose by 11.6% for the top 1%. The same trend has been observed in India (as evidenced by the failure of the ill-advised "India Shining" slogans), China, Russia to name a few countries. The divergence between the wealthy people and the rest in the US has been brought home vividly by the stock market which kept hitting new highs after the 2008 recession even as majority of the people felt their (and their children's and grandchildren's) futures slipping away from their control.
Analysis:
The accepted wisdom about income inequality among economists until the past few decades has been that it was low before Industrial Revolution played a huge part in spiking it. In developed countries that are now in post Industrial revolution phase, income inequality was expected to come down. This was described by the inverted U-shaped Kuznets curve named after economist Simon Kuznets. It assured countries that whatever tough times they were going through at the present moment on their road to Capitalism, there was light at the end of the tunnel in terms of low income inequality once Capitalism in their country matured. Reality has been different and especially after 1970's, wealthy people in most countries have pulled away from others and continue to do so at increasing rates.
The GDP of countries in Western Europe shrank at an average annually compounded rate of 0.01% from AD 1 - 1000. The GDP of Western Europe offshoots (US, UK, Australia, New Zealand, Canada) grew by 0.05% between AD 1 - 1000. Between AD 1000 - 1820, the average annual compounded growth rate was 0.34% for Western Europe and 0.35% for the Western Europe offshoots. Between 1820 - 1998, Western Europe grew at an average annual compounded rate of 2.13% whereas the Western Europe offshoots grew by 3.65% (partly reflecting the massive wealth transfer because of Colonialism and Slavery even though the author prefers to credit Industrial Revolution for this supercharged growth). At the time of American Independence (end of 18th Century), America was more egalitarian than England (which was understandable as England was the preeminent political, economic and military power at that time). Industrial revolution rewarded some people with massive wealth while destroying others' livelihoods. The end of 19th century saw heightened income inequality that was flattened only because of the 2 World Wars. With the dizzying increase in income inequality as a result of the Industrial revolution, popular support for increased government regulation of business and redistribution measures like Income tax increased. By 1944, the top income tax rate in US had risen to 94%. In Western Europe and US, the rising income inequality made Communism an attractive ideology (even if it turned out to be the wrong answer). Countries where Communism captured power (China, Soviet Union) were also the countries where the standard of living remained low. The communist scare in US and Western Europe also nudged the wealthy towards supporting re-distributive policies as a result of which the income share of top 1% fell from 16% in 1940 to 7% in 1970. In 1970's, the twin forces of technological revolution and globalization started tearing at the economic consensus in Western Europe and US. Those 2 factors have allowed some countries (notably, India, China, Russia and Brazil) to grow at much higher rates than developed countries at a similar stage in their history. Within the US, those 2 factors played a huge part in shifting the social and political climate from Treaty of Detroit (strong unions, high taxes, high minimum wage laid out by the American car companies based out of Detroit) to Washington Consensus (Weak unions, extensive deregulation, reduced social welfare spending pushed primarily by Western economists under the assumption that liberal economic order is the panacea for every country in the world). With the collapse of Communism, the Treaty of Detroit lost its hold as American car manufacturers (and business leaders in general), no longer had to fear workers organizing against them.
Both at the end of 19th century and now, the wealthy considered themselves as worthy and deserving recipients of their wealth owing to their (self-perceived) superiority over the not-so-rich. In contrast to the delusional fantasies of middle class and poorer Americans about American Dream, wealthy people like Andrew Carnegie were very clear that the widening inequality lent itself to formation of rigid caste hierarchy (which is not too dissimilar to the traditional definition of caste hierarchy in India - both accrue to a person upon birth and confer advantages depending upon one's position in the caste hierarchy). Because the wealthy have more assets at their disposal, they can invest in opportunities abroad, thus taking full advantage of both domestic and overseas growth opportunities. Washington Consensus has further padded their wealth by reducing their tax burdens at the same time their wealth is increasing. The not-so-wealthy do not have enough assets to invest in opportunities in other countries and have been left out of the huge returns on investment while at the same time suffering the indignity of seeing their skills devalued within their respective countries owing to technology revolution and globalization. Industrial revolution resulted in enormous wealth creation that accrued to a specific group of people. The current explosion in wealth creation has been the result of 2 simultaneous processes - globalization, technological revolution and Washington Consensus operating at the same time in developed economies and emerging markets (India, China, Russia, Brazil). Wealth creation in emerging markets has built on prior knowledge from Industrial revolution that the developed economies went through and as a result, are much farther along compared to developed economies' progress during Industrial revolution. Labor in emerging markets was always cheap even during their socialist and communist past. Developed countries could not leverage it at that time partly due to Cold War and partly due to Treaty of Detroit (which allowed the workers in developed economies much stronger say in how their industries were run). With the spread of Washington Consensus, the developed economies have been able to take advantage of low cost labor in emerging markets. In return, the labor force in emerging markets are exposed to more and better opportunities. The spread of television and internet has brought home the harsh realization about lack of opportunities available for the people in emerging markets. Industrial revolution required people to be available in person to take advantage of its opportunities. The current era of wealth creation does not require a person to be physically present in the country of the specific opportunity (which is why financiers and engineers can make gobs of money sitting in their offices or homes). In developed economies, the middle class and the poor are now at the receiving end of unequal wealth creation opportunities in both regions - developed and emerging markets. Companies, on the other hand, are ideally suited to take advantage of this phenomenon as they can move their operations to areas that will provide them cost advantage while reserving the privilege that comes from keeping their headquarters in a developed economy that has clear cut rules and enforcement. For the middle class and the poor, it is not as easy to shift gears and take advantage of opportunities as companies do.
For a long time, economists have always considered globalization (in general) and Chinese inclusion into WTO (in specific) to be beneficial to workers in the US. Recent studies have challenged that conclusion showing that a significant decline in US employment can be explained through trade with China (referred to as China syndrome). Americans have benefited from the increase in quantity of jobs available to them even though the quality of those jobs (in terms of future earning potential) leaves much to be desired. As an example, the success of Apple iPod has created a large number of jobs in the US (with equivalent number abroad) but most of them were in lowly paid retail, office support, freight and distribution sectors. A small sliver of those jobs (consisting of engineers and other professional workers) have enjoyed the lions share of the wealth that has been generated. This has belied the oft stated belief that globalization lifts all boats - Knowledge workers have benefited disproportionately from globalization while other workers have had to make do with crumbs, or as has happened in some cases, lost their jobs. Economists talk about making the pie bigger thereby ensuring everyone gets a bigger share than before. While the pie has become bigger, the distribution of that pie to workers has been very uneven. For companies, the simultaneous wealth creation mechanisms has been beneficial to their bottom line - iPods are produced in China at a low cost but sold back into China at a hefty premium. For Americans, those mechanisms have not been as beneficial - an example would be the Chimerica model where China's position as the low cost supplier and its purchase of US treasuries allowed Americans to run up their debt to stratospheric levels (that led to the severe effects of 2008 recession). The wealth creation at the end of 19th Century caused severe dislocations among people of developed economies as well but there was an escape valve in the form of Colonialism and Slavery in the rest of the world. In the present time, there are no obvious escape valves short of conquest and war.
While people clump people above a certain income level into the top 1%, there are huge variations within that group - Between 2002 - 2006, the top 1% garnered 75% of the total income growth in the US. The people at the very top (0.1%) get more rich, people below them (rest of the top 1%) feel poor. Political movements like Occupy Wall Street target the 1% without realizing the variations within the 1% - the bottom 99% within the top 1% would probably join the protests if asked to protest against the top 1% of the top 1% (0.01%). As an example, financiers who earn millions look jealously at those who earn billions, similar to Rajat Gupta, the disgraced Goldman Sachs board member who was angling to get on the board of KKR, a private equity firm at the same time he was on the board of Goldman Sachs even though it was an obvious conflict of interest. The amount of disposable income of the top 1% has led to a separate category of consumers called Ultra High Net Worth Individuals (UNHWI). While Europe has the largest number of UNHWI (37.2%), North America is not that far behind (37%). Because Europe and North America were the primary beneficiaries of Industrial revolution, they account for almost 75% of the total UNHWI across the globe. Industrial revolution created a winner-take-all society that allowed a few winners to corner the benefits, with the rest fighting for crumbs.
Immediately after Industrial revolution, technology raced ahead of education so people could drop out of formal education track (school or college) and leverage technology to become rich. With American dominance after Second World War came significant investments in education as a result of which the gap between education and technology narrowed. After 1970's, the de-regulatory push in America kicked into high gear reducing the outlay for investments in education. However, the investments made by America in its education infrastructure paid rich dividends for those who took advantage of it. The importance of education is reflected in the increased income inequality between 1973 - 2005 - Wages in that period rose for people with undergraduate, graduate and post graduate education. That has caused a mad dash among parents in America to ensure their kids get good education (something that is familiar to parents in India and China). It has led parents to try to get their kids into the "right" colleges to ensure their kids have a decent future. It has forced American students to prioritize their education needs ahead of arts and sports. While that is the reality for students in developing and emerging countries, it is a new experience for American kids.
The rapid pace of economic change in recent years has also reduced the amount of second chances a person gets to move ahead in life. Someone who succeeds early in life generally has a leg up on the competition. The meritocracy fetish in thriving business centers like Silicon Valley has meant increasing income inequality between the 1% and the 99%. While Silicon Valley tycoons have taken well meaning measures to maintain a shared professional experience with their employees (at least publicly), the underlying wage gap makes a mockery of their efforts. In contrast to wealthy people at the end of the 19th century, UNHWI of the current era have made their fortunes from wages (working rich) than from capital. They are happy to take credit for their successes but push back when income redistribution is suggested as a possible solution to extreme income inequality.Self made UNHWI are usually frugal and find fault with middle class and poor people for not doing enough to improve their economic lives, conveniently forgetting the breaks they benefited from. Research has shown that higher up the wealth ladder someone is, the more unethical they happen to be (there are always exceptions). The self perception among UNHWI about their self made nature of their wealth was behind the vitriol they directed towards Barack Obama when he had the temerity to upbraid them for bringing the global financial system to its knees even though he did not follow through on his words with actions. Most UNHWI espouse the libertarian philosophy of Ayn Rand even if it sounds dangerously deluded to the rest of the population(99%).
UNHWI make sacrifices in their lives as well - Being available to travel at a moment's notice across the globe means their opportunities to spend time with their families is severely constrained. The rapid pace of technological change has put the super rich also in a precarious position - not getting ahead of the technological change is a recipe for falling off the top 1%. As a result, they are as anxious, overworked and uncertain as the rest of us(99%). Because UNHWI are comfortable across national borders (their continued presence in the top 1% requires them to take advantage of opportunities across the globe), they take advantage of opportunities in different nations but generally do not identify themselves with any one of them(in contrast to corporations who generally locate their headquarters in a country that will provide them the advantages of stable rules and tax breaks even if their operations are spread across multiple countries to take advantage of the wage differential). They also identify far more with each other than with citizens of their birth country. They make sure to pass the advantages they have earned, to their kids by putting them in schools with other UNHWI kids. This has boosted the prospects of colleges like America's Ivy league schools, Stanford, Oxford, Cambridge to name a few. To ensure their kids have a smooth passage in these schools, UNHWI also donate generously to these institutions. As a result, some UNHWI kids leave their parents' home only to find themselves looking up at their parents' name in their school buildings as well. In addition to schools, cities and countries have realized the value of attracting UNHWI - Switzerland and Monaco used to dominate that arena but they now have been joined by London, Singapore, Hong Kong and Dubai. The social calendar of UNHWI is filled with international conferences in keeping with the obsession over work in their lives. One of the reasons TED (Technology, Entertainment and Design) conferences have become so popular is that the presenters are pitching their ideas to people who have the money and power to bring those ideas to fruition. Their success is rising to the top of the heap has convinced them that cut throat competition in conjunction with technology will allow them to be better philanthropists than their predecessors (The ongoing transformation of US educational system from an open, trial and error based system to a closed, test based system has driven by philanthropists like Bill Gates using their purse strings to force data driven decision making in education. The transformation of US public education has also been accelerated by broad support in US (Republicans and Democrats) for the de-regulatory framework that has succeeded in reducing the investment in public education). UNHWI have been able to leverage their enormous wealth to protect their dominant position by tweaking the underlying rules of liberal democracy and capitalism in their favor - an example is the lower tax rate on Capital gains (15%) compared to wages (30%) even though the newly passed tax law should provide some measure of relief for the wage earners. There is a higher chance of an economics or engineering major ending up in the top 1% than arts or humanities major. The representation of women in the top 1% is also abysmal - in Forbes billionaires list in 2012, only 104 out of 1226 billionaires were women and that number would further decrease if women with inherited wealth were filtered out. The gender disparity among UNHWI is glaring, considering the fact that more women graduate from college than men.With the spread of technology revolution, globalization and Washington Consensus, finance, economics and engineering majors have commanded a much higher premium compared to other majors. Men responded to this by targeting these majors whereas women stuck with arts and humanities.
In feudalism era, heredity and military determined the powerful people in a society. In capitalism era, money and commercial acumen (and its side benefit, political power) determined the powerful people in a society. Communism was pitched as the route for working class to become powerful. However, as the authors of the book 'Road of the Intellectuals to Class Power' argued, highly educated technocrats wrested power from the working class in communist countries. While developed economies were pointing out the hypocrisy in Communist countries in stripping workers of power while fashioning themselves as workers utopia, they have come to resemble the communist countries in that technocrats now dominate the political and economic elite in the developed economies as well. An example is the success of Barack Obama and Mitt Romney on the left and right respectively - they do not see eye to eye when it comes to their political beliefs but are empiricists in their world view.
In a market economy, owners of Capital hire managers to put their capital to work (manage companies). A familiar issue is the agency problem where the interests of the agent (the manager) diverge from interests of the owner of Capital. At the present time, the sky rocketing salaries of CEOs (who are managing the company on behalf of an owner (in case of a private company) or shareholders (in case of a public company) are a manifestation of the agency problem. Board of Directors are usually tasked with monitoring the agency problem to ensure it does not adversely affect the company. However, both the CEO and the individuals on the Board usually come from the same UNHWI community which then becomes a case of crony capitalism. Right after Second World War, US government put in place regulations to manage the agency problem with respect to the leaders of companies in the US. It worked so well that the leaders of the companies thought of themselves as public servants working on behalf of the collective interest of the nation at large. The downside was that the CEOs underutilized the assets at their disposal. In 1970's, when economic growth stalled in the US, a new idea took hold - "Pay for Performance" - Managerial compensation would be tied to how well the CEOs did in their jobs and how well their companies performed. The Board structure was left intact. As a result, we now have the opposite effect - Superstar CEOs who pay themselves massive salaries and run their companies into debt before switching jobs and repeating the cycle again. The difference from 1970's is stark - at that time, CEOs on an average made 30 times the salary of an average employee under them whereas in 2005, average salary of CEOs was 110 times that of an average employee. The triple factors of technology revolution, globalization and Washington Consensus has also meant that CEOs are rewarded for being generalists whereas in the 1970's, CEOs were rewarded for being an expert in a specific organizational culture. As a result, more CEOs are now hired from outside the firm thereby reducing wage premiums for those leaders who choose to stay with the same company in the hope of ascending the corporate ladder. Some countries like Britain have tried to rein in executive pay through government regulation without much success. The aspirational underpinnings of American dream has meant that the middle class and poor do not begrudge the high salaries of CEOs as they take it as a sign that even they have an opportunity to make it good in the future, forgetting the very real constraint in the number of CEO jobs available.
After Industrial revolution, economic gains have disproportionately accrued to a small subset of people who are talented in their fields and who took advantage of early opportunities to showcase their talent - the author refers to them as superstars. They have been able to leverage mass production in their respective fields to increase their wealth. With the explosion of Internet, Long tail theory (proposed by Chris Anderson) explained how niche artists and small audiences would have market power in the Internet era along with behemoths like Amazon and Google. As time has gone on, the Long tail theory has been shown to have minimal effect. Part of the reason is that the factors of technology revolution, globalization and Washington Consensus has transformed most sectors into winner take all situations leaving only crumbs for people who make up the long tail. Explosion of wealth among UNHWI has influenced the emergence of superstars in different professions like artists, lawyers, architects etc.,. Once the superstar professional has successfully managed to impress a UNHWI, it ensures other UNHWI hire that professional for their needs as well. Because UNHWI consider themselves as a community separate from the middle class and the poor, they place more weight on recommendations from their fellow UNHWI. As a result, the superstar professional is able to leapfrog others in their profession who find themselves losing ground and have difficulty staying relevant. Marshall effect, named after Alfred Marshall, explains how superstar professionals can charge higher premiums for their work with UNHWI. Rosen effect, named after Sherwin Rosen, explains how superstar professionals can leverage technology to reach a much larger audience (An example would be Sivaji Ganesan acting on stage versus his roles in movies - acting on stage is limited by the range of his voice but movies can be dispersed across the globe through the magic of technology). Some professions like chefs have successfully managed to register their presence among UNHWI and the rest - they provide expensive personal service for the UNHWI and leverage that cachet to market their cheaper mass produced services to the rest of the population. Matthew effect explains another set of people who benefit from the general prosperity of UNHWI. According to Saint Matthew, one of the apostles of Jesus Christ, whoever has wealth in abundance gets even more of it without losing it. Some examples would be Kardashians (who are famous for being famous), Nobel prize winners (Multiple scientists might work on a discovery for which Nobel prize is awarded. However, not all of them are recognized even though all of them were responsible for the discovery. Research has shown the eventual Nobel prize winner is able to super charge their earnings while the rest get penalized through reduced earnings over their lifetime).
According to Roger Martin, Capital and talent are going their separate ways now. After Industrial revolution, Labor and Capital diverged and that conflict reverberated across government and society. During Industrial revolution, Capital had the upper hand because the owners owned the means of production (for example, a factory and its machines). Labor relied on cooperation with Capital to earn their living. In the clash between capital and talent, the tools of Production are no longer under the control of Capital. As a result, a knowledge worker is able to shop their knowledge to the highest bidder without having to worry about Capital. Dwarfing everyone in the UNHWI are the financiers - bankers, private equity firms, hedge fund managers. They represent both Capital and Knowledge and charge hefty premiums. Washington Consensus has further helped them by reducing their tax burdens in the past 30 years.
Business leaders who have successfully steered their companies under normal times can be caught flatfooted during revolutionary times. They understand the scope and urgency of the change facing them but double down on their execution, thinking that a better execution will provide them safe harbor during normal and revolutionary times. As a result, they completely miss the paradigm shift and end up as cautionary tales in case studies in business schools. This also explains why people from societies that are chaotic (example India) thrive when they move up the economic ladder in a rule bound society (example, US). Their experience with chaos prepares them to question their assumptions and consequently, they are in a much better position to take advantage of revolutionary times. In contrast, business leaders steeped in developed economies take their assumptions (for example about stability and rule of law) for granted and are in a much weaker position when faced with revolutionary change. People grew up as outsiders in a nation but later became insiders are better able to navigate times of chaos - An example would be the oligarchs in Russia in early 2000s, 6 out of 7 were Jews who grew up in anti-semitic Russia. The flip side to this approach are people who missed revolutionary change going on right under their noses - An example is Russian tycoon Yuri Milner who witnessed revolutionary change in Russia but from the vantage point of a cushy job at World Bank in Washington. By the time he was able to convince himself to let go of his job in Washington and take risks, the privatization bonanza during the transition of Russia from Communism to Capitalism had passed him by. He was however lucky to get another shot with the spread of social networks. Learning from his previous misstep, he invested in Russian social networking site followed by Facebook that made him a multi billionaire.
Political power follows the money and UNHWI are well positioned to take advantage of their wealth. Developing and Emerging markets that are the darlings of investors from developed economies have significant income inequality but the responses of each country has been different. While Russia and China have used state power to put the wealthy in their place, Mexico and India have been at the receiving end of the wealth sloshing around in their countries from UNHWI - the proliferation of scams in India in the recent years is a testament to the power of UNHWI to get the politicians to do their bidding. US has slowly but surely become a poster child for a more invidious type of corruption - While there is a widely publicized corruption index for legally defined corrupt activities, there is not one for regulatory and cognitive capture activities that have as much (if not more) impact on how politicians regulate businesses. In developed economies, legally defined corrupt practices are kept to a minimum by having enough safeguards to deter people from engaging in it but there is a far more extensive regulatory and cognitive capture by business. In developing and emerging markets, there are far more legally defined corrupt practices (as evidenced by their low position on corruption index) but much less regulatory and cognitive capture (mainly because a weak legal and regulatory regime places low premium on laws and regulations). The business friendly rules promulgated by politicians from both parties in US is evidence of the significant regulatory and cognitive capture - An example is the success of banks in getting very friendly legislation passed in US congress even after wrecking the global financial system and bringing economic ruin to millions of families. In contrast, Canada escaped most of the after effects of the 2008 financial meltdown because the Canadian government insisted on regulating financial institutions in a robust manner. The difference in wages between people who enforce the regulation (career bureaucrats) and those who are targets of it (business) ensures a revolving door between the two whereby regulators leave their government jobs to earn higher wages with the industries they used to regulate. The slow erosion of norms surrounding public service in developed economies has resulted in politicians becoming very rich themselves. Till very recently it was perfectly legal for US congress people to engage in insider trading using regulatory information on companies their committees oversaw on a regular basis. Career bureaucrats are prohibited from insider trading on the same information showing the difference between elite and not so elite in stark relief.
Other Books for Reference:
Why Nations Fail: The Origins of Power, Prosperity and Poverty - Daron Acemoglu and James A Robinson
Road of the Intellectuals to Class Power: Sociological Study of the Role of the Intelligentsia in Socialism - George Konrad and Ivan Szelenyi
More Money Than God: Hedge Funds and the Making of a New Elite - Sebastian Mallaby
The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality - Branko Milanovic
Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise - Fraser J.T. Howie and Carl E Walter
Socialist countries like India have always looked upon wealth with suspicion. After the liberalization of the economy in 1991, the pursuit of wealth for its own sake became glamorous again in India as well as in other countries. The implosion of Communism and failure of Socialism across the world meant a general acceptance that Capitalism was the only game in town (even though some countries like Cuba gamely held onto Communism much longer). As the self-proclaimed leader of the Capitalist world, US did a lap of honor with the end of Cold War, marked by triumphalism as evidenced in articles like Francis Fukuyama's 'The End of History'. With time, the success of Capitalism has provided a serious boost to wealthy people by allowing them to capture most (if not all) of its benefits across the globe. With its opponents discredited, any constraining factors that would smooth out the rough edges of Capitalism (Workers' rights, Business Regulation, Income redistribution etc.,.) have been slowly and methodically rolled back. This book talks about the winners (in both developed and developing countries), who took advantage of the shift to Capitalism and raced ahead in wealth creation. The predictable effect has been widening income inequality within and across countries. Americans' illusions about American Dream has blinded them to the sobering reality that not everyone can become rich irrespective of their station in life. The succession of severe political aftershocks after the 2008 recession (Brexit, Donald Trump getting elected as US President) has to do with very real frustrations of people in developed economies who are coming to the (belated) realization that the rosy future sold to them was a worthless bill of goods. The trust people had in the political and economic elite prior to 2008 recession has been replaced by an insecurity and acknowledgement that what they bought into earlier (a prosperous and bright future) was no longer attainable for their children and grandchildren. The economic recovery from the 2008 recession has been uneven - for 99% of the Americans, incomes rose by 0.2% whereas it rose by 11.6% for the top 1%. The same trend has been observed in India (as evidenced by the failure of the ill-advised "India Shining" slogans), China, Russia to name a few countries. The divergence between the wealthy people and the rest in the US has been brought home vividly by the stock market which kept hitting new highs after the 2008 recession even as majority of the people felt their (and their children's and grandchildren's) futures slipping away from their control.
Analysis:
The accepted wisdom about income inequality among economists until the past few decades has been that it was low before Industrial Revolution played a huge part in spiking it. In developed countries that are now in post Industrial revolution phase, income inequality was expected to come down. This was described by the inverted U-shaped Kuznets curve named after economist Simon Kuznets. It assured countries that whatever tough times they were going through at the present moment on their road to Capitalism, there was light at the end of the tunnel in terms of low income inequality once Capitalism in their country matured. Reality has been different and especially after 1970's, wealthy people in most countries have pulled away from others and continue to do so at increasing rates.
The GDP of countries in Western Europe shrank at an average annually compounded rate of 0.01% from AD 1 - 1000. The GDP of Western Europe offshoots (US, UK, Australia, New Zealand, Canada) grew by 0.05% between AD 1 - 1000. Between AD 1000 - 1820, the average annual compounded growth rate was 0.34% for Western Europe and 0.35% for the Western Europe offshoots. Between 1820 - 1998, Western Europe grew at an average annual compounded rate of 2.13% whereas the Western Europe offshoots grew by 3.65% (partly reflecting the massive wealth transfer because of Colonialism and Slavery even though the author prefers to credit Industrial Revolution for this supercharged growth). At the time of American Independence (end of 18th Century), America was more egalitarian than England (which was understandable as England was the preeminent political, economic and military power at that time). Industrial revolution rewarded some people with massive wealth while destroying others' livelihoods. The end of 19th century saw heightened income inequality that was flattened only because of the 2 World Wars. With the dizzying increase in income inequality as a result of the Industrial revolution, popular support for increased government regulation of business and redistribution measures like Income tax increased. By 1944, the top income tax rate in US had risen to 94%. In Western Europe and US, the rising income inequality made Communism an attractive ideology (even if it turned out to be the wrong answer). Countries where Communism captured power (China, Soviet Union) were also the countries where the standard of living remained low. The communist scare in US and Western Europe also nudged the wealthy towards supporting re-distributive policies as a result of which the income share of top 1% fell from 16% in 1940 to 7% in 1970. In 1970's, the twin forces of technological revolution and globalization started tearing at the economic consensus in Western Europe and US. Those 2 factors have allowed some countries (notably, India, China, Russia and Brazil) to grow at much higher rates than developed countries at a similar stage in their history. Within the US, those 2 factors played a huge part in shifting the social and political climate from Treaty of Detroit (strong unions, high taxes, high minimum wage laid out by the American car companies based out of Detroit) to Washington Consensus (Weak unions, extensive deregulation, reduced social welfare spending pushed primarily by Western economists under the assumption that liberal economic order is the panacea for every country in the world). With the collapse of Communism, the Treaty of Detroit lost its hold as American car manufacturers (and business leaders in general), no longer had to fear workers organizing against them.
Both at the end of 19th century and now, the wealthy considered themselves as worthy and deserving recipients of their wealth owing to their (self-perceived) superiority over the not-so-rich. In contrast to the delusional fantasies of middle class and poorer Americans about American Dream, wealthy people like Andrew Carnegie were very clear that the widening inequality lent itself to formation of rigid caste hierarchy (which is not too dissimilar to the traditional definition of caste hierarchy in India - both accrue to a person upon birth and confer advantages depending upon one's position in the caste hierarchy). Because the wealthy have more assets at their disposal, they can invest in opportunities abroad, thus taking full advantage of both domestic and overseas growth opportunities. Washington Consensus has further padded their wealth by reducing their tax burdens at the same time their wealth is increasing. The not-so-wealthy do not have enough assets to invest in opportunities in other countries and have been left out of the huge returns on investment while at the same time suffering the indignity of seeing their skills devalued within their respective countries owing to technology revolution and globalization. Industrial revolution resulted in enormous wealth creation that accrued to a specific group of people. The current explosion in wealth creation has been the result of 2 simultaneous processes - globalization, technological revolution and Washington Consensus operating at the same time in developed economies and emerging markets (India, China, Russia, Brazil). Wealth creation in emerging markets has built on prior knowledge from Industrial revolution that the developed economies went through and as a result, are much farther along compared to developed economies' progress during Industrial revolution. Labor in emerging markets was always cheap even during their socialist and communist past. Developed countries could not leverage it at that time partly due to Cold War and partly due to Treaty of Detroit (which allowed the workers in developed economies much stronger say in how their industries were run). With the spread of Washington Consensus, the developed economies have been able to take advantage of low cost labor in emerging markets. In return, the labor force in emerging markets are exposed to more and better opportunities. The spread of television and internet has brought home the harsh realization about lack of opportunities available for the people in emerging markets. Industrial revolution required people to be available in person to take advantage of its opportunities. The current era of wealth creation does not require a person to be physically present in the country of the specific opportunity (which is why financiers and engineers can make gobs of money sitting in their offices or homes). In developed economies, the middle class and the poor are now at the receiving end of unequal wealth creation opportunities in both regions - developed and emerging markets. Companies, on the other hand, are ideally suited to take advantage of this phenomenon as they can move their operations to areas that will provide them cost advantage while reserving the privilege that comes from keeping their headquarters in a developed economy that has clear cut rules and enforcement. For the middle class and the poor, it is not as easy to shift gears and take advantage of opportunities as companies do.
For a long time, economists have always considered globalization (in general) and Chinese inclusion into WTO (in specific) to be beneficial to workers in the US. Recent studies have challenged that conclusion showing that a significant decline in US employment can be explained through trade with China (referred to as China syndrome). Americans have benefited from the increase in quantity of jobs available to them even though the quality of those jobs (in terms of future earning potential) leaves much to be desired. As an example, the success of Apple iPod has created a large number of jobs in the US (with equivalent number abroad) but most of them were in lowly paid retail, office support, freight and distribution sectors. A small sliver of those jobs (consisting of engineers and other professional workers) have enjoyed the lions share of the wealth that has been generated. This has belied the oft stated belief that globalization lifts all boats - Knowledge workers have benefited disproportionately from globalization while other workers have had to make do with crumbs, or as has happened in some cases, lost their jobs. Economists talk about making the pie bigger thereby ensuring everyone gets a bigger share than before. While the pie has become bigger, the distribution of that pie to workers has been very uneven. For companies, the simultaneous wealth creation mechanisms has been beneficial to their bottom line - iPods are produced in China at a low cost but sold back into China at a hefty premium. For Americans, those mechanisms have not been as beneficial - an example would be the Chimerica model where China's position as the low cost supplier and its purchase of US treasuries allowed Americans to run up their debt to stratospheric levels (that led to the severe effects of 2008 recession). The wealth creation at the end of 19th Century caused severe dislocations among people of developed economies as well but there was an escape valve in the form of Colonialism and Slavery in the rest of the world. In the present time, there are no obvious escape valves short of conquest and war.
While people clump people above a certain income level into the top 1%, there are huge variations within that group - Between 2002 - 2006, the top 1% garnered 75% of the total income growth in the US. The people at the very top (0.1%) get more rich, people below them (rest of the top 1%) feel poor. Political movements like Occupy Wall Street target the 1% without realizing the variations within the 1% - the bottom 99% within the top 1% would probably join the protests if asked to protest against the top 1% of the top 1% (0.01%). As an example, financiers who earn millions look jealously at those who earn billions, similar to Rajat Gupta, the disgraced Goldman Sachs board member who was angling to get on the board of KKR, a private equity firm at the same time he was on the board of Goldman Sachs even though it was an obvious conflict of interest. The amount of disposable income of the top 1% has led to a separate category of consumers called Ultra High Net Worth Individuals (UNHWI). While Europe has the largest number of UNHWI (37.2%), North America is not that far behind (37%). Because Europe and North America were the primary beneficiaries of Industrial revolution, they account for almost 75% of the total UNHWI across the globe. Industrial revolution created a winner-take-all society that allowed a few winners to corner the benefits, with the rest fighting for crumbs.
Immediately after Industrial revolution, technology raced ahead of education so people could drop out of formal education track (school or college) and leverage technology to become rich. With American dominance after Second World War came significant investments in education as a result of which the gap between education and technology narrowed. After 1970's, the de-regulatory push in America kicked into high gear reducing the outlay for investments in education. However, the investments made by America in its education infrastructure paid rich dividends for those who took advantage of it. The importance of education is reflected in the increased income inequality between 1973 - 2005 - Wages in that period rose for people with undergraduate, graduate and post graduate education. That has caused a mad dash among parents in America to ensure their kids get good education (something that is familiar to parents in India and China). It has led parents to try to get their kids into the "right" colleges to ensure their kids have a decent future. It has forced American students to prioritize their education needs ahead of arts and sports. While that is the reality for students in developing and emerging countries, it is a new experience for American kids.
The rapid pace of economic change in recent years has also reduced the amount of second chances a person gets to move ahead in life. Someone who succeeds early in life generally has a leg up on the competition. The meritocracy fetish in thriving business centers like Silicon Valley has meant increasing income inequality between the 1% and the 99%. While Silicon Valley tycoons have taken well meaning measures to maintain a shared professional experience with their employees (at least publicly), the underlying wage gap makes a mockery of their efforts. In contrast to wealthy people at the end of the 19th century, UNHWI of the current era have made their fortunes from wages (working rich) than from capital. They are happy to take credit for their successes but push back when income redistribution is suggested as a possible solution to extreme income inequality.Self made UNHWI are usually frugal and find fault with middle class and poor people for not doing enough to improve their economic lives, conveniently forgetting the breaks they benefited from. Research has shown that higher up the wealth ladder someone is, the more unethical they happen to be (there are always exceptions). The self perception among UNHWI about their self made nature of their wealth was behind the vitriol they directed towards Barack Obama when he had the temerity to upbraid them for bringing the global financial system to its knees even though he did not follow through on his words with actions. Most UNHWI espouse the libertarian philosophy of Ayn Rand even if it sounds dangerously deluded to the rest of the population(99%).
UNHWI make sacrifices in their lives as well - Being available to travel at a moment's notice across the globe means their opportunities to spend time with their families is severely constrained. The rapid pace of technological change has put the super rich also in a precarious position - not getting ahead of the technological change is a recipe for falling off the top 1%. As a result, they are as anxious, overworked and uncertain as the rest of us(99%). Because UNHWI are comfortable across national borders (their continued presence in the top 1% requires them to take advantage of opportunities across the globe), they take advantage of opportunities in different nations but generally do not identify themselves with any one of them(in contrast to corporations who generally locate their headquarters in a country that will provide them the advantages of stable rules and tax breaks even if their operations are spread across multiple countries to take advantage of the wage differential). They also identify far more with each other than with citizens of their birth country. They make sure to pass the advantages they have earned, to their kids by putting them in schools with other UNHWI kids. This has boosted the prospects of colleges like America's Ivy league schools, Stanford, Oxford, Cambridge to name a few. To ensure their kids have a smooth passage in these schools, UNHWI also donate generously to these institutions. As a result, some UNHWI kids leave their parents' home only to find themselves looking up at their parents' name in their school buildings as well. In addition to schools, cities and countries have realized the value of attracting UNHWI - Switzerland and Monaco used to dominate that arena but they now have been joined by London, Singapore, Hong Kong and Dubai. The social calendar of UNHWI is filled with international conferences in keeping with the obsession over work in their lives. One of the reasons TED (Technology, Entertainment and Design) conferences have become so popular is that the presenters are pitching their ideas to people who have the money and power to bring those ideas to fruition. Their success is rising to the top of the heap has convinced them that cut throat competition in conjunction with technology will allow them to be better philanthropists than their predecessors (The ongoing transformation of US educational system from an open, trial and error based system to a closed, test based system has driven by philanthropists like Bill Gates using their purse strings to force data driven decision making in education. The transformation of US public education has also been accelerated by broad support in US (Republicans and Democrats) for the de-regulatory framework that has succeeded in reducing the investment in public education). UNHWI have been able to leverage their enormous wealth to protect their dominant position by tweaking the underlying rules of liberal democracy and capitalism in their favor - an example is the lower tax rate on Capital gains (15%) compared to wages (30%) even though the newly passed tax law should provide some measure of relief for the wage earners. There is a higher chance of an economics or engineering major ending up in the top 1% than arts or humanities major. The representation of women in the top 1% is also abysmal - in Forbes billionaires list in 2012, only 104 out of 1226 billionaires were women and that number would further decrease if women with inherited wealth were filtered out. The gender disparity among UNHWI is glaring, considering the fact that more women graduate from college than men.With the spread of technology revolution, globalization and Washington Consensus, finance, economics and engineering majors have commanded a much higher premium compared to other majors. Men responded to this by targeting these majors whereas women stuck with arts and humanities.
In feudalism era, heredity and military determined the powerful people in a society. In capitalism era, money and commercial acumen (and its side benefit, political power) determined the powerful people in a society. Communism was pitched as the route for working class to become powerful. However, as the authors of the book 'Road of the Intellectuals to Class Power' argued, highly educated technocrats wrested power from the working class in communist countries. While developed economies were pointing out the hypocrisy in Communist countries in stripping workers of power while fashioning themselves as workers utopia, they have come to resemble the communist countries in that technocrats now dominate the political and economic elite in the developed economies as well. An example is the success of Barack Obama and Mitt Romney on the left and right respectively - they do not see eye to eye when it comes to their political beliefs but are empiricists in their world view.
In a market economy, owners of Capital hire managers to put their capital to work (manage companies). A familiar issue is the agency problem where the interests of the agent (the manager) diverge from interests of the owner of Capital. At the present time, the sky rocketing salaries of CEOs (who are managing the company on behalf of an owner (in case of a private company) or shareholders (in case of a public company) are a manifestation of the agency problem. Board of Directors are usually tasked with monitoring the agency problem to ensure it does not adversely affect the company. However, both the CEO and the individuals on the Board usually come from the same UNHWI community which then becomes a case of crony capitalism. Right after Second World War, US government put in place regulations to manage the agency problem with respect to the leaders of companies in the US. It worked so well that the leaders of the companies thought of themselves as public servants working on behalf of the collective interest of the nation at large. The downside was that the CEOs underutilized the assets at their disposal. In 1970's, when economic growth stalled in the US, a new idea took hold - "Pay for Performance" - Managerial compensation would be tied to how well the CEOs did in their jobs and how well their companies performed. The Board structure was left intact. As a result, we now have the opposite effect - Superstar CEOs who pay themselves massive salaries and run their companies into debt before switching jobs and repeating the cycle again. The difference from 1970's is stark - at that time, CEOs on an average made 30 times the salary of an average employee under them whereas in 2005, average salary of CEOs was 110 times that of an average employee. The triple factors of technology revolution, globalization and Washington Consensus has also meant that CEOs are rewarded for being generalists whereas in the 1970's, CEOs were rewarded for being an expert in a specific organizational culture. As a result, more CEOs are now hired from outside the firm thereby reducing wage premiums for those leaders who choose to stay with the same company in the hope of ascending the corporate ladder. Some countries like Britain have tried to rein in executive pay through government regulation without much success. The aspirational underpinnings of American dream has meant that the middle class and poor do not begrudge the high salaries of CEOs as they take it as a sign that even they have an opportunity to make it good in the future, forgetting the very real constraint in the number of CEO jobs available.
After Industrial revolution, economic gains have disproportionately accrued to a small subset of people who are talented in their fields and who took advantage of early opportunities to showcase their talent - the author refers to them as superstars. They have been able to leverage mass production in their respective fields to increase their wealth. With the explosion of Internet, Long tail theory (proposed by Chris Anderson) explained how niche artists and small audiences would have market power in the Internet era along with behemoths like Amazon and Google. As time has gone on, the Long tail theory has been shown to have minimal effect. Part of the reason is that the factors of technology revolution, globalization and Washington Consensus has transformed most sectors into winner take all situations leaving only crumbs for people who make up the long tail. Explosion of wealth among UNHWI has influenced the emergence of superstars in different professions like artists, lawyers, architects etc.,. Once the superstar professional has successfully managed to impress a UNHWI, it ensures other UNHWI hire that professional for their needs as well. Because UNHWI consider themselves as a community separate from the middle class and the poor, they place more weight on recommendations from their fellow UNHWI. As a result, the superstar professional is able to leapfrog others in their profession who find themselves losing ground and have difficulty staying relevant. Marshall effect, named after Alfred Marshall, explains how superstar professionals can charge higher premiums for their work with UNHWI. Rosen effect, named after Sherwin Rosen, explains how superstar professionals can leverage technology to reach a much larger audience (An example would be Sivaji Ganesan acting on stage versus his roles in movies - acting on stage is limited by the range of his voice but movies can be dispersed across the globe through the magic of technology). Some professions like chefs have successfully managed to register their presence among UNHWI and the rest - they provide expensive personal service for the UNHWI and leverage that cachet to market their cheaper mass produced services to the rest of the population. Matthew effect explains another set of people who benefit from the general prosperity of UNHWI. According to Saint Matthew, one of the apostles of Jesus Christ, whoever has wealth in abundance gets even more of it without losing it. Some examples would be Kardashians (who are famous for being famous), Nobel prize winners (Multiple scientists might work on a discovery for which Nobel prize is awarded. However, not all of them are recognized even though all of them were responsible for the discovery. Research has shown the eventual Nobel prize winner is able to super charge their earnings while the rest get penalized through reduced earnings over their lifetime).
According to Roger Martin, Capital and talent are going their separate ways now. After Industrial revolution, Labor and Capital diverged and that conflict reverberated across government and society. During Industrial revolution, Capital had the upper hand because the owners owned the means of production (for example, a factory and its machines). Labor relied on cooperation with Capital to earn their living. In the clash between capital and talent, the tools of Production are no longer under the control of Capital. As a result, a knowledge worker is able to shop their knowledge to the highest bidder without having to worry about Capital. Dwarfing everyone in the UNHWI are the financiers - bankers, private equity firms, hedge fund managers. They represent both Capital and Knowledge and charge hefty premiums. Washington Consensus has further helped them by reducing their tax burdens in the past 30 years.
Business leaders who have successfully steered their companies under normal times can be caught flatfooted during revolutionary times. They understand the scope and urgency of the change facing them but double down on their execution, thinking that a better execution will provide them safe harbor during normal and revolutionary times. As a result, they completely miss the paradigm shift and end up as cautionary tales in case studies in business schools. This also explains why people from societies that are chaotic (example India) thrive when they move up the economic ladder in a rule bound society (example, US). Their experience with chaos prepares them to question their assumptions and consequently, they are in a much better position to take advantage of revolutionary times. In contrast, business leaders steeped in developed economies take their assumptions (for example about stability and rule of law) for granted and are in a much weaker position when faced with revolutionary change. People grew up as outsiders in a nation but later became insiders are better able to navigate times of chaos - An example would be the oligarchs in Russia in early 2000s, 6 out of 7 were Jews who grew up in anti-semitic Russia. The flip side to this approach are people who missed revolutionary change going on right under their noses - An example is Russian tycoon Yuri Milner who witnessed revolutionary change in Russia but from the vantage point of a cushy job at World Bank in Washington. By the time he was able to convince himself to let go of his job in Washington and take risks, the privatization bonanza during the transition of Russia from Communism to Capitalism had passed him by. He was however lucky to get another shot with the spread of social networks. Learning from his previous misstep, he invested in Russian social networking site followed by Facebook that made him a multi billionaire.
Political power follows the money and UNHWI are well positioned to take advantage of their wealth. Developing and Emerging markets that are the darlings of investors from developed economies have significant income inequality but the responses of each country has been different. While Russia and China have used state power to put the wealthy in their place, Mexico and India have been at the receiving end of the wealth sloshing around in their countries from UNHWI - the proliferation of scams in India in the recent years is a testament to the power of UNHWI to get the politicians to do their bidding. US has slowly but surely become a poster child for a more invidious type of corruption - While there is a widely publicized corruption index for legally defined corrupt activities, there is not one for regulatory and cognitive capture activities that have as much (if not more) impact on how politicians regulate businesses. In developed economies, legally defined corrupt practices are kept to a minimum by having enough safeguards to deter people from engaging in it but there is a far more extensive regulatory and cognitive capture by business. In developing and emerging markets, there are far more legally defined corrupt practices (as evidenced by their low position on corruption index) but much less regulatory and cognitive capture (mainly because a weak legal and regulatory regime places low premium on laws and regulations). The business friendly rules promulgated by politicians from both parties in US is evidence of the significant regulatory and cognitive capture - An example is the success of banks in getting very friendly legislation passed in US congress even after wrecking the global financial system and bringing economic ruin to millions of families. In contrast, Canada escaped most of the after effects of the 2008 financial meltdown because the Canadian government insisted on regulating financial institutions in a robust manner. The difference in wages between people who enforce the regulation (career bureaucrats) and those who are targets of it (business) ensures a revolving door between the two whereby regulators leave their government jobs to earn higher wages with the industries they used to regulate. The slow erosion of norms surrounding public service in developed economies has resulted in politicians becoming very rich themselves. Till very recently it was perfectly legal for US congress people to engage in insider trading using regulatory information on companies their committees oversaw on a regular basis. Career bureaucrats are prohibited from insider trading on the same information showing the difference between elite and not so elite in stark relief.
Other Books for Reference:
Why Nations Fail: The Origins of Power, Prosperity and Poverty - Daron Acemoglu and James A Robinson
Road of the Intellectuals to Class Power: Sociological Study of the Role of the Intelligentsia in Socialism - George Konrad and Ivan Szelenyi
More Money Than God: Hedge Funds and the Making of a New Elite - Sebastian Mallaby
The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality - Branko Milanovic
Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise - Fraser J.T. Howie and Carl E Walter
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