By now you may have noticed a common theme in these descriptions of how the banking sector and the financial markets make money: they do so not by creating real wealth but by manipulating a virtual-money economy.
They can only do this because the banks are able to create money at will. This would be fine if they were dealing in matchsticks or Monopoly money, but they are dealing in the same money that is essential to the process of creating real wealth.
The real wealth they purchase with money so acquired is entirely unearned. Landowners also benefit from unearned wealth, but, unlike bankers and financiers, they have not created an entire industry dedicated to its pursuit. They simply buy land from which they receive the benefit of unearned wealth because, ever since the establishment of private property in land ten thousand years ago, nobody has thought to question the entitlements of landowner-ship in a world where most land is owned by very few people.
Unearned wealth is the principal basis for the exercise of elite power.
Democracy didn’t deliver the current economic and financial system. In a properly functioning democracy the economy would be configured to serve the interests of the majority, not a tiny minority. It is the power and influence of a global elite and the coterie of professionals that serves them which sets the global economic agenda today. Why democratically elected governments are unable to challenge this power is a matter for debate. Perhaps they realize that the only way to curb it is through reforms so radical that the mere thought stops them sleeping at night. Whatever the reason, the path to a just and inclusive economy will not be clear until ways are found to curb the privilege of unearned wealth. The only way to do this is to acknowledge and then tackle elite power and entrenched privilege.
The process by which unearned wealth is acquired is sometimes described as ‘rent seeking’. The concept of rent seeking was first outlined by Gordon Tullock in 1967, and given its name by another economist, Anne Krueger, seven years later. Use of the term can be confusing because it brings to four the number of different meanings ascribed to the word rent. It’s worth, therefore, spending a moment on definitions.
As well as the conventional use of the term – you might rent a flat, or a car while on holiday – economists use the word in three different ways. As we noted, Adam Smith used it to describe that part of income that is distributed to landowners. There is also the slightly different concept of economic rent, which is the amount paid for the use of any factor above the minimum necessary to bring it into production. Confusingly, both labour and capital can command economic rent. If you went for a job interview and were ready to accept a salary of £30,000, but your future employer was so impressed with you that she decided to offer you £35,000, the difference is your economic rent.
In rent seeking we encounter yet another form of rent. It is the business of earning money, not by investing effort and resources in trying to generate new wealth, but by working to secure for oneself a greater share of already existing wealth.
Whereas profit seeking describes the process of investing capital in return for a share of the new wealth created, rent seeking is about skimming off a share of wealth created by others.
Rent seeking can take many forms. It might involve lobbying politicians to enact legislation that will make it harder for new producers to gain entry to a particular market. The pre-crash craze for private equity takeovers of perfectly viable businesses is another form of rent seeking. In such cases, the distribution of income between wages and capital is altered substantially, even though the new ‘capital’ supplied makes no contribution to wealth creation. The income earned by rent seekers often comes in the form of land rent. Russian oligarchs, for example, owe their immense wealth to the fact that they were effectively given free use of vast quantities of natural resources after the fall of communism.
Rent seeking always has a cost in terms of resources that could otherwise be applied to the creation of new wealth. Not only is it a legalized form of economic theft, but it also diverts resources from the real economy. And of course, the only people able to engage ‘successfully’ in rent-seeking activities are people who are already so well off that they don’t need to find work in the real economy.
To clarify, legitimate economic activity does not have to involve the conversion of the resources of nature into something physical for consumption. There are thousands of activities, employing millions of people, which produce services for exchange in the marketplace which are perfectly legitimate. This book is printed on paper that began life in a forest, but you didn’t buy the book for the paper, you bought it for what is printed on its pages. The Four Horsemen film that accompanies this book makes even less use of the resources of nature, but thousands of people have paid at the box office to see it, or bought the DVD. Many vital and necessary service industries exist to facilitate and support the exchange of goods and services in the marketplace – retail is perhaps the best example. Income derived from non-tangible service activities is perfectly legitimate as it’s part and parcel of the process by which genuine wealth is created. It’s quite different from the rent-seeking activities of bankers, landowners and speculators. Regardless of the propaganda, none of these activities generates any new wealth or adds any real value to society.
The Greek philosopher Plato said the ratio of earnings between the highest and lowest paid in any organization should be no more than six to one. In 1923, banker J.P. Morgan declared that twenty to one was optimum. Today the earnings ratio between the highest and lowest paid in large corporations can be as much as a thousand to one.
Herman Daly has a clear insight into the problems this causes: “when you are up in the range of five hundred to one inequality, the rich and the poor become almost different species, no longer members of the same community. Commonality of interest is lost and so it’s difficult to form community and to have good, friendly relationships across class differences that are that large.”
There is a further form of rent seeking, driven by more established methods, that has recently become rampant and which negatively impacts the labour market. If, with the proceeds of their rent-seeking activities, top executives of banks and financial institutions pay themselves huge salaries and bonuses, the labour market dictates that senior execs in firms that do create real wealth should be similarly rewarded. This skews the market mechanism because it doesn’t distinguish between the CEO of a rent-seeking investment bank and the CEO of a wealth-creating firm: both end up earning inflated salaries. In order to justify these, they have to keep their shareholders happy. They do this by rewarding them with higher dividends. As a result, a disproportionate share of revenue is taken by shareholders at the expense of wages. Within the distribution of wages, a similarly disproportionate share goes to senior executives at the expense of the rest of the workforce. This doesn’t reflect any change in the contributions of capital and labour, or within the relative contributions of different sections of the workforce; it is a direct result of the impact of rent-seeking behaviour on the labour market. It explains the massive increase in the pay multiples earned by senior executives compared with other employees over the last three decades.
And it gets worse. By shifting incomes from people who would spend most of what they earn on things they need, to people who already have everything they could possibly want, the prospects for future wealth creation are further damaged. The over-paid use their additional wealth to drive up the prices of non-productive assets like land and housing, expensive jewellery and fine art. Looted rent spoils are exchanged for things that represent real wealth. Even the best wines in the world are no longer available to be enjoyed by wine lovers, because they’re appropriated as investment assets. Claret and Burgundy chips are now traded in all the best financial casinos.
There can be no doubt that the economy as currently arranged promotes a totally unfair distribution of wealth.
Bankers, speculators and landowners engage in activities that extract wealth created by others. In companies that do create real wealth, the factors of production are rewarded unjustly. The rich are getting richer at the expense of those who do most of the work. The hangover of empire that has shaped the western economies means that rent-seeking activities are still regarded as entirely legitimate.
Excerpt from Four Horsemen: The Survival Manual.