Old Bankers’ Tales… and Why to Reject Them

“The 1% earned it, so the government should let them keep it.”

Earning money.  Let’s tackle this head on: what does it mean to earn something?

There is, floating around in the American zeitgeist, the idea of demigod entrepreneurs who create the products and companies that make us all better off. These rare, special creatures ought to be compensated for sharing their talents with us in a way that makes us all better off via innovation! Heroic individuals of genius and talent generate enormous social wealth and so “earn” whatever they are paid!

A typical, yet flawed example of this myth, is Steve Jobs. Steve Jobs is an atypical example of the 1% – most of whom are finance or C-class (so CEO, CTO, and the like) executives – because, arguably, he created real value for people.

But note that this narrative depends on two questionable assumptions. The first assumption is that the market worth of an individual’s economic contributions is a measure of the net social wealth they have generated – their “marginal product” in economics-talk.  The second assumption is that the market price commanded by an individual is a fair and just way of distributing income.

Let’s pick apart that first assumption. Where does social wealth come from, actually? Is it really wholly manufactured by a few geniuses? Even expressing it this way makes it absurd on its face. It’s much more likely, in fact, that society itself is the real source of wealth: see Elizabeth Warren’s “you didn’t build that” speech1 for example.

To paraphrase Warren, lucky you if you were able to take advantage of the way society has been set up, but you are not the sole source of value here. The economy depends on a huge number of institutional and social realities that have no price tag.

Consider this: how much of what Apple did was really because of China opening up and allowing US factories? How many Chinese and Vietnamese lifetimes went into each iPhone? How much of what Apple did was because of government investment in the Internet? Also, since Jobs didn’t have a great engineering background, intellectual property was “negotiated” between him and Steve Wozniak. In other words, it wasn’t a one-man-against-the- world situation. If we plopped Steve Jobs in medieval Germany, he would likely wind up plowing some farmland, just like everyone else.

In other words, once you take into account the basically social nature of the background conditions for market success, Steve Jobs doesn’t look like an amazing genius, but rather one individual (kind of jerky and potentially replaceable) in a process that included many factors.

Even if we concede that there is a general, albeit noisy, correspondence between pay and social value, it’s still arguable whether the particular 1% in our society is producing any social value. Those maniacs blew up this shit, after all! We have an elite that is paid by organizations that fail to internalize huge externalities, from environmental costs to financial fragility. To the extent that they are making a profit by ignoring these costs, their resulting pay is not even remotely related to helping society.

Let’s face it: earning doesn’t necessarily mean that we are making society better off, but rather that someone is willing to pay us for our labor and capital. It’s just as likely that individuals are paid really well because they came up with fancy new derivatives to fleece people as it is that they were making the world a better place. To the extent that the system allows you to make money by screwing people over rather than by improving society, there will continue to be a discrepancy between earning and the betterment of society.

Let’s move on to the second assumption, namely that people earn their market value and that such a system is both fair and just.

One overriding element of the Steve Jobs success story is luck. Indeed, luck is one of the features that make markets work – the right person at the right time can make the right trade, product, or innovation.

How does the element of luck square with the concept of justice? If you think of the sheer amount of luck and arbitrariness that is inherent in market rewards, it’s difficult to believe that it corresponds closely to justice, since we generally think of justice as fixed, or, at most, a slowly evolving and emerging concept. In other words, we don’t think we’ll see “justice innovation” coming in the next few years that would make it OK to torture children.

Hold on, though. Maybe there is a loose correspondence after all. Maybe the market implements some form of meritocracy. Those frugal and thrifty people, or those talented and risk-taking people, are the ones that the market rewards.

But at some level this possibility can’t be reconciled with the intrinsic dynamism and random shocks that the market brilliantly delivers. Merit is essentially backwards-looking (“I’m investing time and money to build the widgets that our country already needs”), whereas the free market generally rewards what’s coming up (“We’ve disrupted the field of widgets by creating new, virtual widgets at a fraction of the cost!”).  This kind of technological jump is great, in general, but it also means that the people thinking the hardest about what society already needs might not anticipate the next disruption.  So capitalism is constantly pulling the rug out from under even the most thrifty, frugal, and talented people.  In other words, the extent to which someone “earns” their pay is continuously disrupted by serendipity and noise.

Keeping money.  Now that we’ve talked a bit about the concept of “earning” money, let’s talk about the concept of “keeping” money.  That is, should the government let people keep “their” money rather than  taxing and transferring some of it?

As we discussed above, it’s possible to make the case that lots of currently rich people made their money by a combination of luck and screwing people over. If that is the case, it was never “their” money to begin with. Heavily taxing rich guys is therefore arguably the simplest way just to  smooth-out some of the noise we discussed, and also to create better incentives when our cockamamie legal system dumps tons of riches in the hands of a few folks who obviously are not engaged in the most societally beneficial behaviors.

If that sounds extreme, consider this: we have an enormous number of talented scientists going into finance, even after the financial crisis. In the 50′s and 60′s their counterparts sent people to the moon, but nowadays our most talented people are leaving scientific fields, getting jobs in finance, and then figuring out how to invent complicated and opaque financial products.  That is not because society is now getting a lot more value out of finance and less out of science. It is much more likely because some of the totally unprincipled legal rules we mentioned are resulting in a misallocation of resources, which a more progressive tax system would go a long way towards straightening-out.

Also, when, as we have earlier discussed, there are fewer and fewer goods and services in society that we hold in common, that necessarily means people are starting off their lives from vastly different baselines. Taxes alone cannot fix that. Other countries address inequality in various ways: allocating public goods (such as schools, universal daycare, excellent public transportation) and changing the structure of the labor market.

The lowest mobility places in the US, for instance, are still the black belt and the plantation delta, two regions in the South. This suggests that the current structure of American inequality runs a lot deeper than just tax and redistribution policy. Whether someone has any money to “keep” when he starts off will have a heck of a lot more to do with what part of our lumpy geography of wealth distribution he is from, than with any moral entitlement he may claim.

Finally, strong unions might do more to fix inequality than taxes, while eliminating the (false) perception taxes cause that something is being “taken away” from the rich guy that was already “earned”. Why? Because when we’re in a union, the bargaining clout that comes with standing up to the boss together means the revenue “the company” (i.e. the broad community of people that constitute the firm’s workforce) generates will be distributed more evenly. So the issue of “correcting” an uneven distribution becomes besides the point. And, of course, unions create a political voice for workers to balance out the over-sized modern political voice of corporations.

“Things that hurt the private sector are bad for job creation.”

First, things that the business community perceives as bad for individual businesses might often actually be good for the overall private sector.

For example, standard Economics suggests that firms will hire workers to the extent that doing so increases their net- revenue, meaning the cheaper the worker, the more hiring a firm will do. Higher taxes and more stringent regulations are bad on this view because they make it harder for the revenue vs. cost spread of the next hire to come out positive. But thinking about it this way is like saying—because I got my sandwich faster by cutting to the front of the deli-line, everyone should do it. In other words, breaking down an individual firm’s decision-making calculus about its next hire tells us nothing about what kinds of policies might benefit the system of private sector employment.

There a lot of reasons to think, for example, that policies that set living wage standards at practically double the current federal minimum wage would eliminate race-to-the-bottom pricing of labor. And a more fairly compensated private-sector workforce would actually be in a better position to go out and buy the products and services its employers sell so the system of private sector employment would actually do better. When the wages of Walmart workers are at or near poverty levels while the wealth of Walmart’s founding family is so extraordinary that they could not spend it in several life-times, is that really good for private sector business? When money pools and gets stuck in nooks and crannies of the system, leaving most economic-participants little choice but to turn to public assistance or crime—it is bad for business, private and public.

Second, private job creation does not account for all jobs—there are plenty of government jobs too. We have more control over them and nothing per se makes a private sector job better than a public one. So to the extent (god forbid) Rahm Emanuel were to shut-down a charter school and give its teachers jobs at a resuscitated public institution, why would those jobs be worse?  They would arguable be better because governments don’t run from their debts and vanish as frequently as start-up companies do.

Let’s think even a bit more about public employment. That is, let’s be open to the idea that a national public employment program – an army of workers for creating things instead of destroying them—could reduce a lot of unemployment while building parks, cleaning up the environment, making public art, and the like.

Even just in NYC alone, we owe so much to the Works Progress Administration (WPA) – take a look around. It makes you realize that there’s a lot of labor that society needs for creating things—like parks, bridges, museums, zoos, airports and so on that the market won’t provide  We should be pretty darn proud of the work our public sector employees and other employees working on public projects do; they build and service most of what we take pride-in as a society.


“Entitlements and government waste, like the stimulus, have created too much government debt, which is what brings us down.”

By government waste, which one of the wars does this refer to? Or does it refer to the NSA surveillance budget or the Pentagon drone budget?

Let’s face it, government waste is in the political eye of the beholder. In other words, when a politician says “waste of our tax dollars”, we might say “vital government program”, referring to the same thing. A description of “waste” often has more to do with a view about the objective the government program seeks to fulfill than with the way the government is carrying it out.

The stimulus is often thrown-out there as the classic example of government waste, so let’s tackle it directly. It’s piddling in the gross domestic product (GDP) scheme of things: a one time cost of $1.2 trillion vs. $14 trillion annually And parts of it did valuable things like helping cities avoid laying-off teachers or improving the energy efficiency of our electric grid. We really could have used more of it and spent it better.. In addition, we might want to worry about climate change at least as much as government budgeting and debt.

Why compare two different things like climate change and budgets? Because of their similar time horizons. In other words, we ignore certain pressing issues like climate change which lie on that same time horizon as the deficit—let’s say 2030—so why the current obsession with the government’s alleged waste and debt?

Even so, let’s admit that an overly indebted government will have trouble borrowing at reasonable rates, which would be bad . It gives bondholders too much clout and makes the government timid when it comes to projects that might prevent debt rollover. It is also no substitute for a more thorough taxation scheme and a functional political system that can raise taxes when needed for important projects.

If we decided to stop depending so heavily on government debt, what are the basic steps we’d need to take to get out of it?

As far as Social Security is concerned, we don’t actually have a problem. While there’s a bit of a short-term squeeze, there are no problems we can’t fix in the medium term, first by raising the Social Security payroll “cap” (currently $90,000) up to some higher cap of our income, and, second, by making the Social Security payroll tax more progressive.

Next let’s consider healthcare. There have been lots of projections about a severe crisis in healthcare because medical expenditures are rising at an enormous rate. To the extent that government pays those costs, this is a rapidly increasing part of the budget. There are a few reasons for this, some of them give us reason to be hopeful, and others have nothing to do with government waste.

First, it looks like cost growth has slowed in the past year, partly because of how companies have anticipated the onset of Obama’s Affordable Care Act (ACA). Based on extrapolation, it’s not certain that the rising cost of medical care will hold true going forward.

But even ignoring this possible slowdown, healthcare is expected to constitute 25% of the national budget by 2025. Is that actually such a bad thing? If we think about it, it’s a totally civilized society in which the government is an efficient insurance company and, at the same time, a reluctant army (armies cost a lot), especially if you compare this to the current situation in which we pay a large fraction of economic output to the finance sector.

After all, as people get richer, the value of extra “stuff” becomes less meaningful but the value of an additional year of life or additional sense of security always remains high. Seen in this light, the expected continuing increase in healthcare expenditures and social insurance is possibly reasonable in a rich country. Ideally, we would want to hold down cost, but if people are actually demanding more healthcare, then so be it.

And lastly, it is becoming pretty well understood that the inefficiencies in our health care system are not on the government side. They come mostly from private practitioners who have financial stakes in all sorts of procedures sick people undergo, so a lot of doctors do well when we are (and stay) sick, rather than by making (and keeping) us healthy2. Remember, almost all government employees get serviced by private doctors. It is only the insurance which the government supplies.

So Social Security is not a big deal and healthcare is a big deal, but it might be reasonable, and to the extent it is a mess, it is largely a mess of the private sector’s making stemming from all the privatization that happened to that field in the 70s and 80s. That leaves things like wars, defense, and the unconscionable government subsidies of pet industries like big pharmaceuticals (Bush II made it illegal for the government to bargain better prices for Medicare Part D drugs) and the Finance Sector (the ongoing bail out) to name but two.

A final point about the myth that governments are inherently wasteful and that too much debt is dangerous: at what point is the bond market, as a whole, going to freak out and stop lending to the profligate inefficient US government? There would have to be something better, safer, and more liquid than the US for this to ever happen. Clearly, this is not happening, and does not look like it is going to happen any time soon.

“The current structure best allocates capital, and, in any event, if we suppress it, it will just go elsewhere and the US economy will suffer.” 

Let’s first dig into the assumptions embedded in the first part of this statement. If we peek under the covers at what “best allocates capital” means, we’ll see that it assumes that we are doing something especially clever right now which makes our current system “the best”. What would that be?  If anyone responds by claiming—our markets are “free”; then get them to give you an address to a “free” market, and it better not be Wall Street or the “The Merc” (the Chicago Mercantile Exchange). Those markets are not only heavily (if inadequately) regulated; they were created as a result of regulation. As Bernard Harcourt has wonderfully explained in “The Illusions of Free Markets”3, the commodities exchanges in Chicago were created out of a multi-decade public-private partnership bent on suppressing “bucket-shops” and other “off market” trades. All markets are regulated, indeed, without heavy regulation all you have is people conspiring to set prices and grab things away from one another without paying for them. The only question therefore is whether the current set of regulation is any good, and for all the reasons we have discussed earlier, it is not.

Further, even if we concede that the financial system is doing an adequate job of allocating capital to “profitable” businesses, do we think that  profit is really a good proxy for social well-being? Recent history ought to give us precious little solace that dumping capital in the most “profitable” firms is going to put money where it will do the most good.

Let’s move on to the second part of the myth, namely that capital might move to other countries if the US has strong regulation.

First, investors all over the world want to invest in the US. It is hard to believe that will change any time soon, but it is even harder to believe they are coming here because we have lax capital regulations. They are coming here because despite the financial hits the 99% has taken over the past 25 years, we still have a lot of educated, reasonably well-off people living here who together create a vibrant society compared to many other places in the world. The economic dynamics this book has spent a lot of time exploring are doing tremendous damage to that vibrancy, and, if not checked, will ultimately make the US a poor place to invest (and live). But it is certainly not loose money that brings investors to our shores; and it is certainly no time soon that reasonable capital regulations are going to drive them from these shores.

Our competitors on the regulation front are also the likes of the Cayman Islands, Singapore, and Switzerland. Is that where all the money is going to go? Keep in mind that Europe is no less regulated than the U.S., and although England is a soft spot, it is also under political pressure by its public.

Given this, let’s not worry so much about regulation of capital, but, on the other hand, let’s go ahead and worry about tax havens.  The European Union is currently trying to pass laws about tax havens to make them less available.

On the scale of the world’s money, tax havens are having a pretty serious effect, and they’re even tilting our perception of which countries are net debtors versus creditors. Come to think of it, they don’t generate a lot of jobs for the 99%, so we probably should not worry too much about winning the race to the bottom of that garbage heap.


1 http://www.youtube.com/watch?v=i-P-CoSNYaI

2  For a seminal (but fun) article on this see Atul Gawande, “The Cost Conundrum”, The New Yorker,  June 1, 2009 (www.newyorker.com/reporting/2009/06/01/090601fa_fact_gawande)

See endnote 13 of Chapter 6.

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2 Responses to Old Bankers’ Tales… and Why to Reject Them

  1. 9skeptic says:

    Great chapter. But not beyond improvement. Here are my suggestions:

    First of all, I would list all of the myths you are going to tackle up front.

    Myth 1:
    I would list the various ways people can accumulate enormous wealth and personify each one. My list would be:
    1) Entertainment: Wilt Chamberlain but I would update to Lebron or someone like that (Justin Bieber?) I know the reference talks about Wilt but how many people know him today?
    2) Entrepreneur: Steve Jobs or Bill Gates.
    3) Businessman: Warren Buffett? Jack Welch? Note: Welch is better because he is easier to attack and ran a “real” company which Berkshire is not. But, if you use Buffett you can refer to (or quote from) this interview.
    4) Financial Tycoon, version 1 — running a large company: Lloyd Blankfein, Angelo Mozillo
    5) Financial Tycoon, version 2 — hedge fund magnate: Steve Cohen? John Paulson?
    6) Inherit: Abigail Johnson, David Rockefeller, David Koch, someone from the Duke family

    1-3 generally do something useful for society but it is still clear, as Buffett points out, that they were only able to do what they did because of the society they were in. It is very dubious whether groups 4-6 provide any benefit to society at all. And, I think categories 4 and 5 are growing in importance. 6 has diminished in importance today because it has become easier to amass large fortunes lately, the old ones pale in comparison. But, going forward the money will get “old” and passed on.

    Myth 2:
    I would say sooner that many (almost all) things businessmen say are “bad for business” self-serving arguments. They won’t actually do what they say, they just say it to justify getting what they want. For instance, we were told tax cuts would stimulate the economy and create jobs. Is there any evidence that they did? Actually, the economy did better with higher tax rates (and lower CEO salaries.

    Myth 3: good. No specific comments.

    Myth 4:
    “if you don’t think that profit is a good guide to social well-being, then you certainly should be skeptical that the finance hunt for profit is putting money where it will do the most good.”

    But, many people (including many who I think are in our target audience) do believe that there is a connection between profit and social value. I think we (that is you) need to address it head on. Maybe as a separate myth or maybe in this section (or as part of “myth 1″).

    Also, you seem to move back and forth between personal and corporate taxes. I’m not sure what you are advocating in terms of taxes, especially corporate taxes. The discussion of moving capital (and reference to Henry George) suggests you favor getting rid of corporate taxes and taxing wealth/land and personal income. That’s ok with me but if that’s what you mean, say it more clearly.

    Myth 5

    While it is referred to in the other “myths” I suggest tackling head on the myth that business creates all growth. It is worth addressing the fact that a lot of corporate enterprise (and most of the financial system) is not socially productive at all. It is also worth noting how non-corporate (non-governmental) enterprises (Wikipedia, Firefox, non-profit educational institutions) produce a lot of value. Also, that much government activity is also socially productive.

    You do make some of these points in other places (and could do so more if you expand Myth 1 as suggested above) but it is worth considering attacking it directly. It is basically the myth that the 1% are the “job creators”.

  2. Pingback: Occupy Finance, the book: announcement and fundraising (#OWS) | mathbabe

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