Megan McArdle: Why Are The Rich So Rich?
Because they have all the money? And once you have all the money you write laws that will ensure you can keep the money and make lots and lots more?
Yesterday, Tyler Cowen noted a paper arguing that the income of financial professionals makes up a large proportion of the top incomes. Since income inequality has been growing at the very top, this has led many to the conclusion that the very wealthy--and particularly those in the finance sector--have arranged things so that most of the rising incomes in society go to them.
You mean people actually do things to become rich? It doesn't just happen for "systemic reasons"? I don't believe it!
It's certainly not a thesis that I find impossible.
Could she please make that a little less "in your face" as the kids say? It's just far too confident and straight-forward a concession. Maybe she could have added a "perhaps" or "in certain circumstances."
Markets are governed by rules, and incumbents will seek to alter those rules to their own benefit.
We will remember that she said that. For the rest of her life.
The thesis seems especially convincing in the light of the university-based meritocratic elite that has emerged over the last four decades.
We suppose McArdle herself is one of those university-based meritocratic elite as well. The fact that her father grew wealthy as a New York construction industry lobbyist and therefore was able to spend $38,000 per year on her prep school tuition (as well as her sister's, no doubt), thereby gaining admission to an Ivy League school that she confessed she was woefully under qualified for, undoubtedly has nothing to do with anything. Her rise was due to merit, not money, and her hard work and the skill sets she developed. Any poor person with a 2.93 GPA could have gotten into the University of Pennsylvania as well, we are sure.
Bankers are very cosy with the elites in other fields, which is why you see so many folks from Goldman and other top banks cycling through the policy apparatus of both Democratic and Republican administrations.
That said, the proponents of this thesis are all a bit vague on how, exactly, this feat is managed. What rules, for example, are enabling such a small fraction of bankers to charge such exorbitant fees for IPOs?
Very cunning. It's the absence of rules that helped caused the problem; the lack of regulation on the shadow banking system.
One could argue that rule changes such as the SEC's 2004 decision to allow broker-dealers to increase their leverage ratios made that business much more profitable, while socializing the risk onto the rest of us. But that doesn't explain something that is pointed out in the excerpt on Tyler's blog: the prevalence of hedge fund managers at the very top. [snipped quote]
Perhaps it was lack of regulation and policies that encouraged a massive run-up of debt.
For the "political capture" story to work, you'd want to explain this in terms of the carried interest tax rule.
Wait--wait--! Let us guess! The lower tax rates under Republicans had nothing to do with the super-rich's accumulation of wealth!
Hedge fund managers take a substantial part of their compensation as a percentage of the returns that the fund earns; these returns are taxed, not as ordinary income, but as capital gains, at the lower rate. I haven't heard many convincing explanations of why this should be the case; the compensation may be contingent, but that is not the same thing as putting capital at risk. (For that matter, I think that we should eliminate the corporate income tax, and tax capital returns as ordinary income. But that is an argument for another day.)
But while I can certainly explain the continued taxation of hedge fund income at capital gains rates as a function of lobbying--the Democrats still haven't managed to change this, even though they've been talking about it for years, which seems a bit mysterious given that we just passed a huge financial services reform bill. But that doesn't explain why they're making so much pre-tax income.
Maybe it's because of the lack of regulation that enabled them to create toxic financial instruments that they leveraged to the hilt while taking gigantic fees and bonuses?
A different story--"skills based technological change"--seems like it might be a better fit.
Oh, this is going to be good. By which we mean idiotic and demonstrably wrong.
Arguably, computers are especially useful in analyzing financial markets, which has vastly increased the ability of those with the best computers, and computer skills, and financial theory, to make money off of small anomalies in the market. These people are making the markets more efficient--Bob Rubin's first job was simply calling London, and trading based on the differences between prices in London and New York. And they're profiting hugely from the anomalies they find. (Also, arguably, from taking on an unwarranted amount of tail risk--but except to the extent that computers allowed them to magnify it, the tail risk was there before. The profits weren't.)
Scene: A small hipster bar in Washington, DC.
McArdle: How about I say that bankers are just smarter than everyone else?
Mr. McArdle: You said that before. We gotta come up with a new way of saying the same thing. I know! Computers! They're hard to understand and the people who write those programs and make those cool games are really smart. We'll just say that they're smart computer-y people who know lots of stuff and that's why they're rich!
McArdle: What was that middle part again?
Mr. McArdle: Let's go home. I want to see if my copies of Bioshock and KillZone 3 came in today.
McArdle: It doesn't matter. Nobody can figure out what I'm talking about anyway.
You can even fit the regulatory story into this, from a different angle: the government doesn't have the best computers or theorists, and so it can't keep up with the constantly multiplying financial complexity. If it did, maybe it would crack down. That doesn't speak to capture so much as our willingness to pour resources into regulation. If we were serious about regulation, the SEC would have the best paid guys on Wall Street, not the worst. But that's politically unthinkable.
Regulation is always politically unthinkable. We are not sure why. It's certainly not because of "capture"! Heh, the very idea of bankers being dishonest! Pish and tush!
Besides, that still leaves athletes, executive compensation, and whole lot of other factors--this paper says "The data demonstrate that executives, managers, supervisors, and financial professionals account for about 60 percent of the top 0.1 percent of income earners in recent years, and can account for 70 percent of the increase in the share of national income going to the top 0.1 percent of the income distribution between 1979 and 2005." It's hard to explain how the wealthy are manipulating the regulatory apparatus to make Apple vastly more profitable than it would have been forty years ago.
Not that Apple is one of those financial firms that are the subject of her post, but they are a good diversion from the main point. Which is the rich are rich because they are smarter and better and entirely merit-based, and if you don't believe her, just ask the multi-millionaire who pays her.
(Worth a thousand words)
Note: To be clear, McArdle said that she got into Penn due to her prep school, and got into Chicago due to Penn. Thanks, Lurking Canadian.