Unequal Gains: American Growth and Inequality Since 1700

Peter Lindert and Jeffrey Williamson at VoxEU:

Unequal gains: American growth and inequality since 1700. VoxEU.org: When did America become the world leader in average living standards? There is little disagreement about how American incomes have grown since 1870, thanks to the pioneering work of Simon Kuznets and many others.  Yet income estimates are weak and sparse for the years before 1870.  In spite of that, our history textbooks imply that the road to world income leadership was paved by the institutional wisdom of the Founding Fathers and those who refined it over the two centuries that followed.  While those institutions were well chosen, in a new book we show that British America had attained world leadership in living standards long before the Founding Fathers built their New Republic (Lindert and Williamson 2016). Furthermore, the road to prosperity was far bumpier than the benign textbook tales of American economic progress imply.
Was income ever distributed as unequally between the rich, middle, and poor as it is today?  As we are constantly reminded, the rise in US inequality over the half century since the 1970s has been very steep. The international research team led by Atkinson et al. (2011) has charted the dramatic 20th century fall and rise of top incomes in countries around the world, including the US.  However, until now evidence was not available for before WWI.  Thus, there is still no history of American income inequality for the two centuries before WWI, aside from a few informed guesses. We now supply that distributional evidence back to 1774.
A new approach with new data
Armed with new evidence, we apply a different approach to the historical estimation of what Americans have produced, earned, and consumed.  National income and product accounting reminds us that we should end up with the same number for GDP by assembling its value from any of three sides – the production side, the expenditure side, or the income side. All previous American estimates for the years before 1929 have proceeded on either the production or the expenditure side. 
We work instead on the income side, constructing nominal (current-price) GDP from free labor earnings, property incomes, and (up to 1860) slaves’ retained earnings (that is, slave maintenance or actual consumption). Our social tables build national income aggregates from details on labor and property incomes by occupation and location for the benchmark years 1774, 1800, 1850, 1860 and 1870. No such income estimates were available for any year before 1929 until now. 
Our unique approach leads to big rewards. One reward is the chance to challenge the production-side estimates using very different data and methods.  As we see below, our estimates are often dramatically different. An even bigger reward is that the income approach exposes the distribution of income by socio-economic class, race, and gender, as well as by region and urban-rural location. 
New findings about American income per capita leadership
America actually led Britain and all of Western Europe in purchasing power per capita during colonial times.  Britain’s American colonies were already ahead by 38% in 1700 and by 52% in 1774, just before the Revolution (Figure 1). Angus Maddison’s (2001) claim that American income per capita did not catch up to that of Britain until the start of the twentieth century is off by at least two centuries. 

Figure 1 Real purchasing power per capita: America versus Britain, 1700-2011

Since the 1770s, America’s big income per capita advantage over Britain has not increased.  The only historical moment in which the US soared well above its colonial lead over Britain and the rest of the world came at the end of WWII.  Since then, the American per capita income lead over Britain has fallen back to colonial levels. 
But note the vulnerability of America’s relative income per capita to costly wars. Fighting for independence may have cut American income per capita by as much as 30% between 1774 and 1790.  The causes seem clear – war damage, mortality and morbidity among young adult males, the destruction of loyalist social networks, a collapse of foreign markets for American exports, hyper-inflation, a dysfunctional financial system, and much more. Then, by 1860, the young republic had regained its big income lead, this time by as much as 46%. This was a period of rapid catching up with and overtaking of Western European per capita incomes, including that of Britain. Fast per capita income growth and even faster population growth made the America the second biggest economy in the world by 1860. However, the US lost most of that big lead (again) during the destructive Civil War decade. It gained the lead back once more by 1900, and briefly lost it (again) in the Great Depression of the 1930s.
American colonists probably had the highest fertility rates in the world, and their children probably had the highest survival rates in the world.  Thus, the colonies had much higher child dependency rates, and family sizes, than did Europe – and even higher than the Third World does today. What was true of the colonies was also true of the young Republic.  It follows that America’s early and big lead in income per capita was exceeded by its early lead in income per worker.
New findings about American inequality
Colonial America was the most income-egalitarian rich place on the planet. Among all Americans – slaves included – the richest 1% got only 8.5% of total income in 1774. Among free Americans, the top 1% got only 7.6%. Today, the top 1% in the US gets more than 20% of total income. Colonial America looks even more egalitarian when the comparison is by region – in New England the income Gini co-efficient was 0.37, the Middle Atlantic was 0.38, and the free South 0.34. Today the US income Gini is more than 0.5, before taxes and transfers. Colonial America was also far less unequal than Western Europe. England and Wales in 1759 had an income Gini of 0.52,and in 1802 it was 0.59. Holland in 1732 had an income Gini of 0.61, and the Netherlands in 1909 had 0.56.  Also, if you agree with neo-institutionalists that economic equality fosters political equality, which fosters pro-growth policies and institutions, then America’s huge middle class is certainly consistent with the young republic’s pro-growth Hamiltonian stance from 1790 onwards. That is, the middle 40% of the distribution got fully 52.5% of total income in New England, the cradle of the revolution!
As Figure 2 shows, it did not stay that way. A long steep rise in US inequality took place between 1800 and 1860, matching the widening income gaps we have witnessed since the 1970s. The earlier rise was not dominated by a surge in the property income share, as argued by Piketty (2014). Rather, this first great rise in inequality was broadly based, with widening income gaps throughout the whole income spectrum – rising urban-rural income gaps, skill premiums, gaps between slaves and the free, North-South income gaps, earnings inequality, and even property income inequality.

Figure 2 Income inequality in America, Britain, and the Netherlands, 1732-2010


From 1870 to WWI, American inequality moved along a high plateau with no big secular changes. Rather, the big drama followed afterwards.  Figure 3 documents that the income share captured by the richest 1% fell dramatically between the 1910s and the 1970s, and the share of the bottom half rose, for almost all countries supplying the necessary data. This ‘Great Leveling’ took place for several reasons. Wars and other macro-shocks destroyed private wealth (especially financial wealth) and shifted the political balance toward the left.  The labor force grew more slowly and automation was less rapid, improving the incomes of the less skilled. Rising trade barriers lowered the import of labor-intensive products and the export of skill-intensive products, favoring the less skilled in the lower and middle ranks. And in the US, the financial crash of 1929-1933 was followed by a half century of tight financial regulation, which held down the incomes of those employed in the financial sector and the net returns reaped by rich investors. We stress that this correlation between high finance and inequality is not spurious. Individuals with skilled financial knowledge have been well rewarded during the two inequality booms, and heavily penalized during the one big leveling (or two, if the 1776-1789 years are included).

Figure 3 Income share received by the top 1%, four countries over two centuries

The equality gained in the US during the Great Leveling slipped away after the 1970s.  The rising income gaps were partly due to policy shifts.  The US lost its lead in the quantity of mass education, and its gaps in educational achievement have widened relative to other leading countries. Financial deregulation in the 1980s also contributed powerfully to the rise in the top income shares and also to crises and recessions. A regressive pattern of tax cuts allowed more wealth to be inherited rather than earned. These policy shortfalls are, of course, reversible and without any obvious loss in GDP.
History lessons
American history suggests that inequality is not driven by some fundamental law of capitalist development, but rather by episodic shifts in five basic forces – demography, education policy, trade competition, financial regulation policy, and labor-saving technological change. While some of these forces are clearly exogenous, others – particularly policies regarding education, financial regulation, and inheritance taxation – offer ways to check the rise of inequality while also promoting growth.
Atkinson, A B, T Piketty, and E Saez (2011), “Top Incomes in the Long Run of History,” Journal of Economic Literature 49, 1: 3-71
Lindert, P H, and J G Williamson (2016), Unequal Gains: American Growth and Inequality since 1700, Princeton N.J., Princeton University Press
Maddison, A (2001), The World Economy: A Millennial Perspective, Paris, OECD Development Centre Studies
Piketty, T (2014), Capital in the Twenty-First Century, Cambridge Mass., Belknap Press

Robber Barons: Honest Broker/Hoisted from 1998

J. Bradford DeLong (1998): Robber Barons:

First draft October 13, 1997; second draft January 1, 1998.

I. Introduction

'Robber Barons': that was what U.S. political and economic commentator Matthew Josephson (1934) called the economic princes of his own day. Today we call them 'billionaires.' Our capitalist economy--any capitalist economy--throws up such enormous concentrations of wealth: those lucky enough to be in the right place at the right time, driven and smart enough to see particular economic opportunities and seize them, foresighted enough to have gathered a large share of the equity of a highly-profitable enterprise into their hands, and well-connected enough to fend off political attempts to curb their wealth (or well-connected enough to make political favors the foundation of their wealth).

Matthew Josephson called them 'Robber Barons'. He wanted readers to think back to their European history classes, back to thugs with spears on horses who did nothing save fight each other and loot merchant caravans that passed under the walls of their castles. He judged that their wealth was in no sense of their own creation, but was like a tax levied upon the productive workers and craftsmen of the American economy. Many others agreed: President Theodore Roosevelt--the Republican Roosevelt, president in the first decade of this century--spoke of the 'malefactors of great wealth' and embraced a public, political role for the government in 'anti-trust': controlling, curbing, and breaking up large private concentrations of economic power.

Their defenders--many bought and paid for, a few not--painted a different picture: the billionaires were examples of how America was a society of untrammeled opportunity, where people could rise to great heights of wealth and achievement on their industry and skill alone; they were public benefactors who built up their profitable enterprises out of a sense of obligation to the consumer; they were well-loved philanthropists; they were 'industrial statesmen.'

Over the past century and a half the American economy has been at times relatively open to, and at times closed to the ascension of 'billionaires.' Becoming a 'billionaire' has never been 'easy.' But it was next to impossible before 1870, or between 1929 and 1980. And at other times--between 1870 and 1929, or since 1980--there has been something about the American economy that opened roads to the accumulation of great wealth that were at other times closed.

Does it matter whether an economy is open to the accumulation of extraordinary amounts of private wealth? When the economy is more friendly to the creation of billionaires, is economic growth faster? Or slower? And what role does politics play? Are political forces generally hostile to great fortunes, or are they generally in partnership? And when the political system turns out to be corrupt--to serve as a committee for extracting wealth from the people and putting it into the pockets of the politically well-connected super-rich--what is to be done about it? What can be done to curb explicit and implicit corruption without also reducing the pressure in the engine of capital accumulation and economic growth?

These are big questions. This essay makes only a start at answering them.

After this introductory section, the second part of this essay reviews the economic history of America's great fortunes over the past hundred and fifty years. It tries to draw connections between the wealth of those at the very top of the wealth distribution, and wider measures of economic inequality and growth.

The third section of this essay focuses on the robber barons of a century ago. How did they make their money, by and large? The fourth section focuses on a few case studies in which politics--political influence and leverage--turned out to be more than usually important in creating and maintaining great fortunes.

The fifth and last section draws somewhat optimistic conclusions. If the presence of billionaires does not seem to materially accelerate economic growth, at least it does not significantly retard it--and it may reflect eras of structural change that lay the groundwork for subsequent rapid leaps of economic growth. If democratic politics withes to curb private accumulations of wealth, it can do so without materially affecting long-run rates of growth. There are cases in which wealth and political power work in partnership, and in which the government becomes a committee for the exploitation of the rest of society for the sake of the politically powerful. But even corrupt democratic governments are not that corrupt, and genuine public purposes are accomplished in the making of great fortunes.

Since this is a Carnegie Endowment publication, I should pause here for an aside: among the chief of the robber barons was Andrew Carnegie, the turn-of-the-last-century steelmaster who dominated American heavy industry and who subsequently established the Carnegie Endowment to promote world peace--to try to work toward a world in which Ministers of Foreign Affairs would cease to think of bombs and bullets and think, instead, of trade and dialogue. Like most of the robber barons, Carnegie was a mass of contradictions--as if he was not one but three or four different people at once.

There was the son of the Scottish peasant, who had been forced off the land to America when the landlords wanted to replace peasant farmers with grazing sheep and when the coming of the power loom to Britain had destroyed the livelihood of the perhaps 4% of the British population who wove thread into cloth by hand in their cottages--the so-called 'handloom weavers.' There was the extremely energetic and intelligent young-man-in-a-hurry in the U.S. telegraph and railroad industries, trying to impress his supervisor Thomas Scott, a high Pennsylvania Railroad executive, with his diligence and foresight.

There was the iron master who had the best grasp in America of what the best technologies for making iron and steel were going to be--and who had the (rare) sensibility to recognize where potential economies of scale were so large that the best business strategy was to build up capacity well ahead of demand and then use it by underselling all your competitors.

There was the union-buster who unleashed his lieutenant Henry Clay Frick to destroy the Amalgamated Iron and Steel Workers union's control over the Homestead, Pennsylvania steel plant: one of the bloodiest episodes in the already-bloody nineteenth century history of American labor relations.

There was the senior industrialist who threatened the financial capitalist J.P. Morgan with an extended price war that would cost Carnegie perhaps $100 million (a large sum, at that time: think of it as the equivalent of perhaps $8 billion today) but that would in all likelihood bankrupt the sprawling, less-efficient steel firms that Morgan had assembled--who threatened Morgan with this unless Morgan were to raise the money on Wall Street to buy Carnegie out. Morgan did so, and claimed that he had made Carnegie the richest man in the world.

And there was the philanthropist trying to figure out what to do with all his money--and deciding that the thing to do was to establish the Carnegie Endowment for International Peace, and to subsidize the building of libraries all across the United States. He was a man of great powers, of great flaws, of great benevolence, and great ruthlessness.

II. Wealth Concentration and 'Billionaires'

A. Economy-Wide Wealth Concentration

When the United States was founded in 1776 it was--Black slavery very much definitely aside--a relatively equal, and relatively free, society (see Jones, 1980). It was relatively equal because the indigenous population had not yet recovered from the wave of Eurasian diseases brought by Christopher Columbus, and they had no military technology to match that of the European settlers. So land was essentially free. And landlords--and rent--were unknown.

The United States was relatively equal because it was only relatively free. If you were white, the country was sparsely populated enough that anyone who did try to make you an 'indentured servant'--essentially a serf--soon found that he had to treat you like a free laborer, or see you leave town with no possibility of return.

But if your skin was anywhere near black, the presumption was that you were somebody's slave.


As best we can tell, the United States at its founding had about the same level of wealth concentration as in the mid-1970s, at the high tide of the redistributional push of the post-Great Depression social insurance state. Perhaps 18 percent of the wealth was held by the wealthiest one percent of households.

Between the Declaration of Independence and the end of America's Civil War in 1865 wealth concentration increased a little. On the one hand the slaves were freed (although their 'freedom' was a transition from being chattel property to being a despised and oppressed minority). On the other hand agricultural land located close to major transportation routes was no longer effectively free. We acquired landlords, and the first industrialists.

Between 1870 and 1900 the United States became an industrialized economy--the leading industrial nation in the world. And wealth became markedly more concentrated. We think that the share of national wealth held by the richest one percent of households peaked at around 45 percent sometime around 1900.

After 1900 the concentration of wealth began a slow decline. Wars--and the higher taxes and inflation that accompanied them--took a heavy toll of the financial wealth of the rich. Stock market booms (like the 1920s and the 1960s) saw wealth concentration take a step upward; but prolonged bear markets (like the 1930s and the 1970s) eroded wealth concentration. The coming of the social-democratic social insurance state eroded wealth concentration: near-universal education boosted the productivity and wages of those near the bottom of the pyramid, progressive income and estate taxes trimmed some wealth off the top, and explicit government wage policy--minimum wages, restrictions on connections between finance and industry, and support for union-centered collective bargaining--shifted the distribution of income and wealth toward labor without producing mammoth amounts of classical unemployment (see Lindert and Williamson, 1976).

Economists still argue over the extent to which the severe restrictions on immigration introduced in the 1920s diminished the supply of unskilled labor and so led to diminished wealth concentration (see O'Rourke and Williamson, forthcoming).

Whatever the causes, wealth concentration fell, and further in the 1960s as a result of the expansion of social democracy and in the 1970s as a result the collapse of the real value of the stock market and the inflation of the 1970s.

And whatever the causes, the period since the mid-1970s has seen wealth concentration in the United States increase more rapidly than ever before--even during the heyday of industrialization in the last decades of the nineteenth century. Aggregate measures of wealth concentration today are greater than at any time since the election of Franklin D. Roosevelt in the Great Depression, and are within striking distance of the peak in wealth concentration reached during the Gilded Age (see Wolff, 1994).

B. Billioniares

Overall shifts in wealth concentration are matched by changes in the wealth of those at the very top of the income distribution. Today we call those at the very top of the income distribution 'billionaires'--for their wealth is more than one billion dollars. According to Forbes Magazine's attempts to count, the year 1996 saw some 132 billionaires in America--and of the top twenty, at least four owed their wealth to Microsoft: the three Microsoft billionaires William Gates, Paul Allen, and Steven Ballmer, and Intel founder Gordon Moore whose wealth has been greatly multiplied by the synergies between Microsoft software and Intel microprocessors over the past two decades.

Generalize the idea of a 'billionaire': a billionaire in the past is someone whose estimated total wealth then was as large a multiple of average GDP per worker in the United States then as a billion dollars today is a multiple of average GDP per worker in the United States today. Note that this generalization arbitrarily ignores a number of issues. Let me mention one: perhaps we are more concerned not with wealth but with control. After the death of the elder J.P. Morgan, Standard Oil company president John D. Rockefeller reportedly remarked that Morgan--who had died with an estate worth (then) less than $100 million or so (the equivalent in relative income terms of perhaps $8 billion today)--was 'not even a very rich man' (see Carosso, 1987). And Morgan was not very rich, if you happened to be John D. Rockefeller. But during the panic of 1907 when all factions of New York's financial oligarchy were working together to try to keep the network of financial claims from collapsing into near-universal over-leveraged bankruptcy, Rockefeller and his people had done exactly what Morgan and his people had asked when they had asked them to do it (see Corey, 1930). Morgan's power appeared to vastly exceed his wealth.

Focusing on wealth relative to the median income, however, on this definition there are today in America five and a half times as many billionaires today as there were in 1982--132 compared to 23. And there were half again as many billionaires in 1982 as there had been in 1957--when it appears that there were 16. That was a low point. 1925 saw approximately 32 billionaires. 1918 saw approximately 30. And 1900 saw approximately 22.

Robber Barons

A generation before 1900 we find few. In 1865 there may have been two billionaires--William B. Astor (whose father John J. Astor had made a fortune in the fur export trade, and who had compounded it by investing in New York City real estate), and Jay Cooke (who had sold the bonds that had financed the United States government's successful suppression of the slaveholders' rebellion in the Civil War of 1861-65). But perhaps not.

A billion dollars today is the total economic product of 20,000 average workers in the United States. Not even the richest of the pre-Civil War southern slaveholders disposed of that much property. And probably William Astor and Jay Cooke did not, at least not at the end of the Civil War.

It is striking how closely numbers of 'billionaire' match shifts in aggregate wealth inequality: when the frequency of billionaires in the labor force is high, wealth concentration is high. A simple linear regression predicts that the frequency of billionaires would drop to zero should the share of wealth held by the top one percent drop to twenty percent or so--and, indeed, we find no billionaires back when wealth concentration was so low.

Economic historians try to account for the history of wealth concentration byf the changing dynamic of the supplies of factors of production and of the changing technologies of production. Their stories sound convincing. But the factors they appeal to are very different from those factors that lead to the appearance and disappearance of very great fortunes. Very great fortunes have three origins:

  • inheritance, plus a stock market boom.
  • persuading the government to do your enterprise a truly massive favor. being at the right place at the right time: creating an enterprise of truly enormous social utility--and thereafter both retaining the market power to turn a large chunk of that extra social utility into firm profits, and
  • retaining a sufficient ownership share and access to capital markets to turn capitalized firm profits into an enormous fortune.

These causes of immense wealth have nothing to do with the determinants of the relative supplies of skilled and unskilled workers, or with the technological requirements of production. It makes me think that the overall level of wealth concentration is much more a 'political' and a 'cultural' phenomenon than an 'economic' one: that we through our political systems and our attitudes have much more to do with the concentration of wealth than does the dance of factor supplies and technology-driven factor demands.

III. The Robber Barons of a Century Ago

A. The Robber Barons of 1900

Look at America's billonaires as they stood at the peak of wealth concentration--and the peak of the relative frequency of billionaires-- in approximately 1900. Nine out of the twenty-two fortunes were railroad fortunes: fortunes made constructing and operating the 200,000 miles of railroad track that were built to cover the United States in the nineteenth century. Three of the fortunes were inherited. Five were in finance--and in 1900 finance meant almost exclusively railroad finance.

Robber Barons

There were a few non-railroad fortunes: one ironmaster (Andrew Carnegie), a couple of department store owners, and stray fortunes derived from other industries. But you do not go too far wrong if you remember that the first wave of American billionaires' fortunes were railroad fortunes.

So how do we evaluate these railroad fortunes? What do we think of names like Leland Stanford, Colis Huntington, Jay Gould, and James J. Hill?

First, we think that they were very different people. James J. Hill was a superb engineer and manager. E.H. Harriman had extraordinary abilities to pick engineers to improve the operations of the Union Pacific Railroad. His friends said that E.H. Harriman (father of future U.S. Ambassador to the Soviet Union Averell Harriman) was honest and incorruptible.

His enemies had a different view. There was one stockholder's meeting at which E.H. Harriman, as chairman, made the surprise ruling that because the corporation laws of the state of Illinois did not recognize proxies, that the part of the corporation's bylaws which did recognize proxy votes was illegal and could not be applied. Hence the proxy votes of his clients that J.P. Morgan had brought to the meeting were invalid, and J.P. Morgan's candidates for the Board of Directors would not be elected (see Corey, 1930).

This is the second thing about the robber barons: they all were ruthless.

But everyone agreed that they would rather do business with E.H. Harriman than with Jay Gould, who never bothered to learn anything about railroad operations, costs, or technology. While Secretary of the Erie Railroad, Jay Gould refused to enter the shares that British investors had bought on the company's books--hence disenfranchising foreign investors. The Erie's stock price plummeted, as investors concluded that Jay Gould was paying the railroad's money into shell construction companies that Gould owned and were doing no work. Eventually Jay Gould mortgaged his other assets, bought up shares of the Erie, and announced his retirement from involvement in the railroad. The Erie's stock price jumped--investors rejoiced that Gould would not be around in the future to loot the railroad. But approximately one-fifth of the capitalized expected future value of not having to deal with Jay Gould in the future went straight into Gould's own pockets (see Adams, 1886; Adams, 1916).

And this is the third thing to note about the turn of the century robber barons: even though the base of their fortunes was the railroad industry, they were for the most part more manipulators of finance than builders of new track. Fortune came from the ability to acquire ownership of a profitable railroad and then to capitalize those profits by selling securities to the public. Fortune came from profiting from a shift--either upward or downward--in investors' perceptions of the railroad's future profits. It was the tight integration of industry with finance that made the turn of the twentieth century fortunes possible.

The fourth thing that stands out about the robber barons is how completely, totally corrupt they all were--or, rather, if we allow them to defend themselves, how completely and totally corrupt was the system in which they were embedded. As Californian Collis Huntington reportedly wrote in 1877, explaining why he was in Washington D.C. pouring bribe money out like water:

If you have to pay money [to a politician] to have the right thing done, is is only just and fair to do it.... If a [politician] has the power to do great evil and won't do right unless he is bribed to do it, I think... it is a man's duty to go up and bribe (see Josephson, 1934) ...

B. Early in the Twentieth Century

Between 1900 and 1930 the list of billionaires grows (from 22 to 30 or so). It loses its concentration around railroads and their financing. The industries in which the billionaires of 1918 made their fortunes are highly diverse: photography, retailing, chemicals, tobacco, farm machinery, automobiles, food processing, local municipal railroads, oil, steel, and finance.

Two things are worthy of note about the billionaires of 1918:

First, their industries are almost identical to those that Chandler (1982) studied in his book on the rise of the modern managerial corporation. They were all industries in which there was the potential for enormous economies of manufacturing scale through the application of technology. They were all industries in which attaining the volume of sales necessary to come anywhere close to realizing such economies of scale depended on the ability to sell to a national market. The railroad network had to be in place to allow the products to be shipped cheaply and quickly, and firms had to invest in building up a sales network to support nationwide distribution.

Robber Barons

In industry after industry Chandler finds the seeming paradox: near monopoly or near oligopoly (as larger competitors take advantage of economies of scale to drive out smaller ones), coupled with falling prices (as near-monopolists and oligopolists find their marginal cost curves falling as output expands).

The billionaires of 1918 or so come as close as we will ever find to being examples of situations in which enormous wealth comes from being in the right place at the right time--able to build large organizations to take advantage of hitherto unexploited economies of scale, and retaining large enough ownership stakes and access to the capital market to then transform expected future profits into present wealth.

Second, what turned these individuals into billionaires was Wall Street's willingness to buy their companies. In case after case--and this is where the financiers of 1918 got their billion dollar fortunes--the financier's job was to allow the founding entrepreneur to retire, to bring in a professional management to keep the business going, and to reassure those who are going to purchase the founding entrepreneur's ownership share that this is a prudent and worthwhile investment.

The jump in wealth of the founders of these lines of business was intimately tied up with the creation of a thick, well-functioning market for industrial securities. And that would turn out to be a source of weakness when Wall Street came under fire during the Great Depression.

C. Other People's Money

Many in America in the first thirty years of this century feared and hated the super-rich. Some feared and hated the super-rich because they thought that the rich corrupted the legislature. They were not completely wrong: Senator Aldrich from Rhode Island, for example, was called the 'Senator from Standard Oil.' Indeed, his descendants married the Standard Oil clan: recall that the American Vice President in the 1970s, Nelson A. Rockefeller, was Nelson Aldrich Rockefeller. People who wanted to compete with the Pennsylvania Railroad by building an alternative line from west to east across the Apallachian mountains somehow found that their requests for Pennsylvania corporation charters never emerged from the committees of the Pennsylvania legislature.

But rather more feared the super-rich not because they corrupted politics (or, in the view of the super-rich, were exploited by a politics that was already corrupt), but because they had power.

'They control the people through the people's own money.' So wrote left-wing crusader and future Supreme Court Justice Louis Brandeis in 1913, as he tried to mobilize Progressives for a political offensive to break the financial stranglehold that he saw John Pierpont Morgan, Morgan's partners, and their few peers hold over America at the turn of the century (see Brandeis, 1913). Every time in the first decade of the twentieth century that an American corporation had sought to raise more than $10,000,000 in capital, it had done so by hiring the services of and paying commissions to the partnership of J.P. Morgan & Co or one of three other, smaller investment banks.

If Morgan did not think he should help a corporation raise money, money would not be raised. The firm's expansion plans would not be carried out. The flow of investment in the United States was thus directed to and the expansion of industrial capacity took place in industries and firms that Morgan and his few peers wished to see expand, not elsewhere.

This was the reverse side of the role played by J.P. Morgan and his peers in helping entrepreneurs retire from their companies and capitalize their fortunes. To the extent that successful participation by a company in the market for industrial securities required that Morgan or one of his peers validate the company's prospects--and Morgan and his peers did all think alike--the Wall Street financial oligarchy did have a surprisingly large ability to direct American investment in large corporations around the time of World War I (see U.S. Congress, 1913).

The perspective from the high seats of the partnership of J.P. Morgan and Company, or from those of the other billionaires of 1920 whose wealth was founded upon dominant market positions in industries with increasing returns to scale was very different. In the view of Morgan's partners, they appeared to have power over the economy only because investors trusted their financial judgment. If they did anything other than fund those lines of business that promised the highest profit, they would soon find their ability to direct the flow of capital vanishing. In the view of any of the others, their wealth depended on their commitment to sell at the lowest price and in the highest volume. If they did anything else, they would soon find one of their competitors outstripping them in economies of scale, and they would soon vanish (see Carosso, 1987).

Their attitude was similar to that you find the Microsoft billionaires expressing today. 'Yes,' they say:

We have a dominant market position and enormous profits. But IBM had a dominant market position and enormous profits in 1988. Wang Laboratories had a dominant market position and enormous profits in 1983. If we do not pay close attention to the market, Novell or Netscape or Sun or some competitor now unknown could destroy our business in the next decade--even though we do have 90% of the market today.

But the Progressives did not believe that the billionaires were just the helpless puppets of market forces. In 1896 Democratic presidential candidate William Jennings Bryan called for the end to the crucifixion of the farmer by a gold standard working in the interests of Morgan and his fellow plutocrats. Fifteen years later Louis Brandeis warned Morgan partner Thomas Lamont--after whom Harvard University's main undergraduate library is named-that it was in fact in Morgan's interest to support the Progressive reform program. If Morgan's partners did not do so, Brandeis warned, the Progressives would recede. Their successors on the left wing of American politics would be real anarchists and real socialists (DeLong, 1991).

Louis Brandeis and company did not much care whether the billionaires of what they called the 'money trust' were in any sense economically efficient. In Brandeis's mind, they evil because their interests were large. Brandeis saw American development as depending on:

the freedom of the individual. The only way we are going to work out our problems in this country is to have the individualfree to work and to trade without the fear of some gigantic power threatening to engulf him every moment.

Thus size alone made a billionaire's fortune 'dangerous, highly dangerous.'

Given the heat of political hostility, it is somewhat surprising to me that the large fortunes lasted as long as they did. The so-called 'money trust' was subject to two major congressional investigations. The first took place in 1912-1913, and was conducted by a special House committee counseled by Samuel Untermyer (a former lawyer for the Rockefeller interests whom, it appears, was unhappy at least in part because he thought he had not received his proper share of the profits from the creation of the Amalgamated Copper Company; see U.S. Congress, 1913; Lawson, 1905). The second took place in 1932-1933, and was conducted by the Senate Banking Committee.

Populists from the American midwest found this set of issues a reliable one, and their senators took turns calling for political and economic changes to reduce the power exercised by the super-rich. (Note, however, that the son of one of these midwestern senators--the Charles Lindbergh who was the first to fly nonstrop across the Atlantic Ocean--married Anne Morrow, the daughter of J.P. Morgan and Company partner Dwight Morrow.)

The political debate was resolved only by the Great Depression. The presumed link between the stock market crash and the Depression left the securities industry without political defenders. The old guard of Progressives won during the 1930s what they had not been able to win in the three earlier decades.

Ironically, it was Republican president Herbert Hoover who triggered the process. Hoover thought that Wall Street speculators were prolonging the Depression and refusing to take steps to restore prosperity. He threatened investigations to persuade New York financiers to turn the corner around which he was sure prosperity waited. Thus, as Franklin D. Roosevelt put it, 'the money changers were cast down from their high place in the temple of our civilization.' The Depression's financial market reforms act broke the links between board membership, investment banking, and commercial banking-based management of asset portfolios that had marked American finance before 1930. Investment bankers could no longer be commercial bankers. Depositors' money could not be directly used to support the prices of newly-issued securities. Directorates could not be interlocked: that bankers could not be on the boards of directors of firms that were their clients.

D. The Drying-Up of the Flow of Billionaires

Whatever else Depression-era financial reforms did (and there are those who think it crippled the ability of Wall Street to channel finance to new corporations) and whatever else the New Deal did (and it did a lot to bring social democracy to the United States and to level the income distribution), one important--and intended--consequence was that thereafter it was next to impossible to become a billionaire.

Not that it was ever easy to become a billionaire, mind you, but the channels through which lucky, skilled, dedicated, and ruthless entrepreneurs had ascended were largely closed off.

Power to commit large sums of money to industrial or other enterprises no longer rested in the hands of Wall Street financiers: there was no possibility for someone who was basically on operating company executive Leland Stanford or a Charles Schwab raising money on Wall Street or otherwise by large-scale borrowing: to borrow on a large scale you had to be an investment banker divorced from manufacturing or construction operations, or a commercial banker divorced from both operations and from securities issues.

A Charles Schwab or a Leland Stanford could then direct the flow of finance to an enterprise that would provide him with an enormous fortune. But after 1933 an investment banker--a Douglas Dillon or a Prescott Bush--would have to turn the money raised over to professional operating managers because of the separation of ownership from control.

Thus between the late 1920s and the mid 1950s the number of billionaires in America dropped in half as the labor force grew by at least forty percent. Old billionaires dropped off the list; new ones were rarely added. If not for two industries--aluminum, and oil--the proportion of billionaires would have dropped much further and faster. Aluminum proved to be a source of enormous wealth because of aluminum's unique, lightweight role in the aircraft industry (especially the military aircraft industry) and because of the near-monopoly over Jamaican sources of ore held by Alcoa, the Aluminum Corporation of America. Oil proved to be a source of enormous wealth because there was a lot of oil in the ground, and a lot of people willing to make very risky bets on undeveloped Texas oilfields in the hope of becoming very rich.

Robber Barons

The hostility of Roosevelt's New Deal to massive private concentrations of economic power was effective: the flow of new billionaires dried up, as the links between finance and industry that they had used to climb to the heights of fortune were cut.

Did the hostility of America's political and economic environment to billionaires between 1930 and 1980 harm the American economy? Did it slow the rate of economic growth by discouraging entrepreneurship? As an economist--someone who believes that there are always tradeoffs--I would think 'yes.' I would think that there must have been a price paid by the closing off of the channels of financing for entrepreneurship through which E.H. Harriman, James J. Hill, George F. Baker, Louis Swift, George Eastman, and others had made their fortunes.

But if so, there are no signs of it in aggregate growth data. Taken together the 1930s and the 1940s were average decades as far as long-run economic growth is concerned. And the 1950s and 1960s were definitely above-average decades as well. There were worries that the absence of industrial princes was harming the American economy. Early in the 1930s Adolf Berle and Gardiner Means (1932) raised the possibility that the relative decline of investment banking meant that firm executives had become effectively independent. Executives could use the resources of the firm to rally support for their slates of candidates in annual meetings, while slates of potential executives opposed to current management had no effective channels to use to rally support.

Before 1929 a potential insurgent management team seeking a change in a firm's policy could have gone to talk to Morgan. If he found their arguments convincing the old management might soon be gone and old policies reversed. After 1945 they had to find some way of reaching widely-scattered individual shareholders and of convincing them that it was worth their while to support a change of control. This lack of long-term relationships between those investors who provided the money and the managers who governed the corporation frightened even John Maynard Keynes. But it is very hard to put a solid quantitative shape onto these fears: it is hard to see any quantitative evidence that the political backlash against the billionaires harmed the American economy.

E. The Return of the Super-Rich

The years since 1980 have seen the return of the super-rich in the United States. Some of this is due to the great stock market boom of the past decade and a half, which has carried many of those who inherited their wealth and whose ancestors had never achieved 'billionaire' status into the billionaire category. These are America's first true inherited aristocracy: the first generation of those with immense social and economic power who have inherited it.

More of the return of the super-rich is due to the blurring of the lines between financiers and corporate managers as the Depression-era order of American finance has fallen apart. It is once again possible to raise large sums of money and then direct them to suit one's own interest, rather than turning them over to salaried managers interested in perpetuating organizations.

And perhaps we can discern the rise of a new 'leading sector,' akin in the creation of many of America's present-day billionaires to the role played by the railroads in late nineteenth century America. Combine electronics, software, entertainment, and telecommunications, and you have what may become one single industry early in the next century--and an industry that is producing a very large share of the current crop of billionaires: a quarter or more.

Robber Barons

IV. Wealth and Politics

In the 1860s, on the western slope of California's Sierra Nevada mountain range, Colis Huntington and Leland Stanford won a government contract to build a railroad from San Francisco to the east. The government offered them, in incentives, $24 million in government financing and 9 million acres of land. They had then negotiated with the cities and towns of central California: if a town did not contribute funding to the railroad, the railroad would avoid that town--and it would in due course disappear.

It was claimed that Huntington, Stanford--then also Governor of California--and their partners had built the railroad without putting up a dime of their own money (see U.S. Congress, 1873).

By 1869 they had built the Central Pacific Railroad was built, from San Francisco out to Ogden, Utah, where it met the Union Pacific. The stockholders of the Central Pacific then discovered that the railroad was in horrible financial shape.

Some $79 million of stocks and bonds (including the $24 million from the government) had been floated, and the cash had been expended. $79 millon in cost of materials and payment for construction had been paid to the Central Pacific Credit and Finance Corporation. The Central Pacific Credit and Finance Corporation had spent some $50 million in wages and materials costs to build the railroad, and its shareholders had pocketed the remaining $30 million.

Who were these shareholders? Colis Huntington, Leland Stanford, and two of their other partners. Who were the Central Pacific executives who had approved this arrangement with the Credit and Finance Corporation? Colis Huntington, and Leland Stanford...

Stanford University, in Palo Alto, California, is today a very nice place indeed.

The financing of the other half of the United States's first transcontinental railroad line was even worse. The Union Pacific which ran from the Missouri River to meet the Huntington-Stanford line used the same plan on a larger scale: skim off the profits into a contstruction company owned by insiders, the Credit Mobilier, and leave the government and the other invetors with a railroad near bankruptcy.

To keep political support--to keep the government land grant and construction subsidies flowing--the officers of the Credit Mobilier used Massachusetts congressman Oakes Ames as an intermediary, to distribute stock not in the railroad but in the construction company to influential members of the legislature. In 1873 Oakes Ames panicked, thinking that he was about to be sacrificed to a public outraged at corruption in railroad subsidies. So he testified that he had given stock to: Representative James Brooks, legislative leader of the opposition Party; future President James Garfield, the Vice President, the Vice President elect, several of President Grant's cousins, perhaps thirty others.

The legislative uproar ended in the impeachment of Ames and Brooks--one member from each party--and with the agreement of the two major political parties to try their best to forget that the whole thing had ever happened (see U.S. Congress, 1873).

From this narrative it is easy to reach a judgment: the post-Civil War program providing subsidies to western railroads was a disaster, a way of transferring $100 million of the people's wealth to a few politically well-connected plutocrats. It would have been much better if the program had never been attempted.

Yet a closer look at the situation dissolves the certainties that underlie this judgment. For even with all the political influence that a judicious channeling of wealth back into the pockets of legislators could buy, and even with mammoth government subsidies to build long-distance railroads, their construction was still a near-run thing.

Consider the fate of the Northern Pacific Railroad.

Jay Cooke had been one of the principal financiers of the Civil War era: he and his staff of salesmen had found buyers for the bonds that enabled Abraham Lincoln to pay for the armies that marched down the Mississippi, through Georgia, and to Richmond--and that freed the slaves. During the war Cooke had become a close friend of the leading union general, Ulysses S. Grant, who was president from 1868 to 1876.

After the Civil War ended, Jay Cooke went into the business of railroad finance and construction. He proposed to build not through the deserts of the south, and not over the high Rocky Mountains and the Sierra Nevada (the route of the Central-Union Pacific line), but from the Great Lakes in the northern United States to the Pacific coast, roughly to Seattle.

Perhaps Jay Cooke did not get as lavish a deal in subsidies. Perhaps he and his executives were worse at supervising construction. They were certainly worse at bribing the Congress: the executives of the Northern Pacific seemed to think that Congress should vote subsidies primarily because they were in the public interest, and only secondarily because their palms had been greased.

In any event, by the middle of 1871 it was clear that the Northern Pacific needed more money. It was also clear that there was no point in having half a northern transcontinental railroad. No one lived between the Mississippi-Missouri valley in the middle of the country and the Pacific Coast.

As financiers tend to do when they run into trouble, Jay Cooke borrowed and bet again: he committed the borrowing capacity of his banking house to funding the railroad. But that was not enough. Revelations from the Credit Mobilier scandal helped scare off British investors in the Northern Pacific, who wondered if they would be left with a highly-leveraged and unprofitable railroad while the profits went into the hands of some insiders' construction company. In the fall of 1873 the Northern Pacific Railroad and Jay Cooke--who had been one of the richest men in the United States five years before--went bankrupt. The collapse of the Northern Pacific triggered the panic of 1873. The share of the non-agricultural labor force employed in railroad construction fell from 10% in 1873 to 2% three years later. The U.S. economy went into a depression, and did not emerge from depression until 1879.

Thus of the three groups--all with mammoth government subsidies, and all willing to pour bribe money out like water to keep the flow of subsidies coming--that tried to build transcontinental railroads in the 1860s and 1870s, one (the southern route) never got private financing, one (the two groups combining to build the central route) built a railroad line and together pocketed a spectacular $70 million in profits, and one (the northern route) went bankrupt, dragging the American economy into depression as a result.

And when the dust settled the United States did have a transcontinental railroad. You could travel from New York to San Francisco. And without the offer of mammoth government subsidies such railroad construction would not have happened for another two decades. It was not until the late 1880s and 1890s that transcontinental railroads were built without the offer of mammoth government subsidies.

So there is an alternative reading of the situation: that the subsidies promised were sufficient to call forth the desired investment, but not large enough to make riskless fortunes for politically well-connected entrepreneurs. (After all, the most politically well-connected entrepreneur, Jay Cooke, went bankrupt trying to build his transcontinental railroad.) That the bribes paid out to congressmen were an unfortunate consequence of the corruption of Gilded Age politics, but were only a small part of the capital gambled (and in the Northern Pacific's case, lost) on linking the Atlantic and Pacific coasts. And that the fact that legislators skimmed off a share of the profits for themselves does not mean that the policy of railroad construction was bad policy.

Now not every political interference in railroad building represented sound public policy. What was the sound public policy when judges beholden to Jay Gould refused to order him to allow British shareholders of the Erie Railroad to vote in corporate elections? The case of the transcontinental railroads, in which the policy of subsidization had a rationale is probably an exception (although it was the source of the largest of the railroad fortunes).

Nevertheless, it seems that--given the corruption of American politics at the time--allowing Colis Huntington and Leland Stanford to make their fortune (and to pay off congressmen) was an inescapable part of the price of building a transcontinental railroad in the 1860s. And to those who value the railroad and the economic development that such works of infrastructure made possible, this particular set of robber barons becomes harder to condemn.

As we move away from railroads, government plays a smaller and smaller role. Meat packers based in Chicago used federal government regulation as a competitive weapon, but as a defensive weapon to protect themselves from exclusion from eastern urban markets where local economic interests could dominate legislatures and exclude competition under color of regulating 'health and safety.' The Texas oil fortunes of the 1950s and 1960s depended upon the successful price-fixing strategies of the Texas Railroad Commission, which kept oil prices higher and thus the fortunes of the Hunts and Gettys far higher than would otherwise have been the case.

But once one leaves the railroads behind, government power seems to be exerted as often to try to curb the power of billionaires as to enhance it. Consider today: Microsoft's fortunes owe little to government actions to establish its market share and market power, yet the Justice Department's antitrust division is the principal threat to Microsoft's continued existence. Beyond the railroads, the principal dynamic appears to be populist American distrust of large fortunes, rather than political influence exerted by billionaires.


V. Tentative Conclusions

So what can Americans expect from their current crop of billionaires? Or rather what can they expect from the processes that have allowed their creation?

They should be extremely dubious about billionaires' social utility.

Their relative absence from the 1930s to the 1970s did not seem to harm economic growth in the United States. Their predecessors' claim to much of their wealth is, to see the least, dubious. And their large-scale presence was associated with the serious corruption of American politics.

Perhaps those who are going to be industrial statesmen have as reasonable a chance of truly being industrial statesmen in an environment hostile to billionaires, as in an environment friendly to their creation: at that level of operations, after all, money is just how people keep the score in their competitions against nature and against each other. Theodore N. Vail was a powerful industrial statesman in his role as head of the American telephone company, yet he did not become a billionaire (see DeLong, 1991).

On the other hand, their personal consumption is only an infinitesimal proportion of their total wealth. Much less of Andrew Carnegie's fortune from his steel mills went to his own personal consumption than has gone to his attempts to promote international peace, or to build libraries to increase literacy.

The child who in mid-nineteenth century Scotland painfully learned to read from the handful of books he had access to in his family's two-room cottage as they fell closer and closer to the edge of starvation--that child is visible in the Carnegie libraries that still stand in several hundred cities and towns in the United States, and is visible around us now.

Adam Smith wrote about the rich of his day that they:

only select from the heap what is most precious and agreeable. They consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only... the gratification of their own vain and insatiable desires, they [inevitably] divide with the poor the produce of all their improvements. They are [thus] led by an invisible hand to make nearly the same distribution of the necessaries of life [as] ...had the earth been divided into equal portions (Smith, 1776)...

He was not completely wrong.

So if there is a lesson, it is roughly as follows: Politics can put curbs on the accumulation of extraordinary amounts of wealth. And there is a very strong sense in which an unequal society is an ugly society. I like the distribution of wealth in the United States as it stood in 1975 much more than I like the relative contribution of wealth today. But would breaking up Microsoft five years ago have increased the pace of technological development in software? Probably not. And diminishing subsidies for railroad construction would not have given the United States a nation-spanning railroad network more quickly.

So there are still a lot of questions and few answers. At what level does corruption become intolerable and undermine the legitimacy of democracy? How large are the entrepreneurial benefits from the finance-industrial development nexus through which the truly astonishing fortunes are developed? To what extent are the Jay Goulds and Leland Stanfords embarrassing but tolerable side-effects of successful and broad economic development?

I know what the issues are. But I do not yet--not even for the late nineteenth- and early twentieth-century United States--feel like I have even a firm belief on what the answers will turn out to be.


Charles Francis Adams (1886), Chapters of Erie (New York: Henry Holt).

Charles Francis Adams (1916), Charles Francis Adams, an Autobiography (Boston: Houghton-Mifflin).

Clarence Barron (1930), They Told Barron (New York: Harper and Brothers).

Clarence Barron (1931), More They Told Barron (New York: Harper and Brothers).

Adolf Berle and Gardiner Means (1932), The Modern Corporation and Private Property (New York: Harcourt, Brace, and World).

Louis D. Brandeis (1913), Other People's Money and How the Bankers Use It (New York: Frederick Stokes).

Vincent Carosso (1987), The Morgans: Private International Bankers (Cambridge: Harvard University Press).

Alfred D. Chandler (1982), The Visible Hand (Cambridge: Harvard University Press).

U.S. Congress (1873), The Credit Mobilier Investigation. House Reports, #77, 42nd Congress, 3d Session (Washington, DC: GPO).

U.S. Congress (1913), The Concentration of Control of Money and Credit. Pujo Committe Report (Washington, DC: GPO).

Lewis Corey (1930), The House of Morgan (New York: Howard Watt).

J. Bradford DeLong (1991), 'Did J. P. Morgan's Men Add Value?: An Economist's Perspective on Financial Capitalism,' in Peter Temin, ed., Inside the Business Enterprise: Historical Perspectives on the Use of Information (Chicago, IL: University of Chicago Press for NBER), pp. 205-36.

Alice Hanson Jones (1980), Wealth of a Nation to Be (New York: Columbia University Press).

Matthew Josephson (1934), The Robber Barons (New York: Harcourt, Brace, and Company).

T.W. Lawson (1905), Frenzied Finance (New York: Thayer-Ridgway).

Peter Lindert and Jeffrey Williamson (1976), Three Centuries of American Inequality (Madison: University of Wisconsin).

John Moody (1904), The Truth About the Trusts (New York: Moody).

John Moody (1919), The Masters of Capital (New Haven: Yale University).

John Moody (1919), The Railroad Builders (New Haven: Yale University).

Kevin O'Rourke and Jeffrey Williamson (forthcoming), Globalization and History (Cambridge: MIT Press).

R.E. Riegel (1926), The Story of the Western Railroads (New York: Macmillan).

Edward Wolff (1994), Top Heavy: A Study of Increasing Inequality in the United States (New York: Twentieth Century Fund)."

The Grand Strategy of Rising Superpower Management

Xi jinping Google Search

Munk School Trans-Pacific Partnership Conference: Geopolitics Panel

Revised and Extended: I could now talk about the risks of the Trans-Pacific Partnership. You have already heard a lot about the risks in the previous session here. You have heard about dispute resolution and about intellectual property. You have heard about instituting largely-untested dispute resolution procedures in such a way that they will be very difficult indeed to amend or suspend or replace or adjust in the future.

We all know very well the eurozone’s ongoing experience. We remember that the euro single currency is in its origins a geopolitical project. We remember the origins of the eurozone at Maastricht—the decision of the great and good of Europe that something needed to be done to bind Europe more closely together in the wake of the absorption into the Bundesrepublik of the German East and the collapse of the Soviet Empire. The creation of a single currency was clearly something.

But “we must do something; this is something; therefore we must do this” is a very dangerous syllogism to serve as a basis for any form of technocratic government. The inability of Europe to back itself out of and adjust away from unwise commitments made in the founding of the euro has not been a source of sunny happiness and light in Europe over the past now-eight years.

We all remember that, back in the late eighteenth century, the United States Constitution was at the very forefront of the most advanced intellectual thinking in its ultra-modern and ultra-aggressive innovation policy. The inclusion in the founding constitutional document itself of profound intellectual property protections—the power to by law reserve rights to make and use inventions and discoveries “for a term of years” in order to encourage the useful arts and sciences—was a bold step. But the bold step stopped before writing down the number of years for which rights were to be reserved. The term of intellectual property protection was left to the discretion of the legislature: either none whatsoever, or one day, or seven years, or as long as would encourage inventive and innovative activity—that was for the legislature to decide and revisit and revise as it wished.

We all remember how, back at the end of World War II, John Maynard Keynes and Harry Dexter White at Bretton Woods set about constructing their piece of the international economic institution. Keynes and White, however, did not hard-code policies and quantities into an effectively-unamendable treaty. Rather, they constructed agencies. And they then gave them discretion.

My last trip outside the United States before this trip to Toronto was a trip last December to the Rockefeller villa in Bellagio, Italy, on Lake Como—a trip to discuss Thomas Piketty’s Capital in the Twenty-First Century. Piketty writes about how it is the nature of capitalism that plutocrats and entrepreneurs invest not just in productive capital and beneficial technologies but in political influence in order to rejigger the system of property rights in order to acquire and protect economic rents. How much of what is in the TPP is part of that process rather than a good-faith technocratic effort to construct a better international trade, investment, innovation, and intellectual property-mobilization system for us frogs who live around the pond that is the Pacific Ocean?

All these considerations suggest that the TPP poses considerable risks as a leap into the untested dark. We do not know much about how these dispute and intellectual property provisions will actually work on the ground. And I have no idea how, in a decade, the negotiators of TPP anticipate backing-out of TPP'a mechanisms if on a decade they change their mind about their desirability.

Alternatively to the risks, I could now talk about the potential benefits of the TPP. We heard much less about those in the previous panel.

I could talk about how productivity depends on the division of labor, and the division of labor depends on the extent of the market, and the global trans-Pacific market is the largest we can find—or would, if it included China. I could talk about the benefits of economic integration both in enabling productivity-boosting specialization and incentivizing innovation. I could back up into political economy. I could quote James Madison on how the legislatures of Republican government are always prone to the disease of faction—rent-seeking by special interests—how one important cure for faction is extent of territory that reduces the relative power of each particular faction, and how a set of economic rules that spans an economy the size of the Pacific Ocean will be less vulnerable to rent-seeking by interests that would otherwise merely have to capture the legislature of one national government.

I could talk about how there is $4 trillion in present value in net static economic gains to the trans-Pacific economy from the TPP. And I could point out that those gains are static gains: they do not include the effects of any of the many invention, innovation, investment, spread of ideas, or political-economy virtuous circles that such a $4 trillion productivity boost would produce. I could conclude with observations about how static estimates tend to lowball our assessments of the gains—that the differences between more and less free-trade economies are vastly greater, and the share of those differences plausibly attributable to openness to world trade substantially greater, than estimates produced by the types of calculations that underpin the $4 trillion number.

I could then conclude with reflections on on model building and the estimation of the effects of trade deals. That conclusion would start with a reminiscence of a day in 1994: I was sitting in my office in the US Treasury, just before the start of the lame-duck session that was to pass the Uruguay Round. One of then-Treasury Secretary Lloyd Bentsen's consiglieri walked into my office. He said: "Brad! Your task is to get the Economist to endorse the Uruguay round as a $1 trillion global tax cut! Then no Republican will dare oppose it!” And I found that Robert Cumby and I could indeed do it, and do it relatively straightforwardly.

But this is not a panel on the risks of TPP. This is not a panel on the benefits of TPP. This is not a panel on increasing-returns models and the assessment of trade deals. This is, indeed, not a panel on the political economy of trade policy in the U.S. in the 1990s.

This is a panel on geopolitics.

So let me talk about geopolitics.

And let me talk about the geopolitics of managing our relationship with the immense rising superpower across the great ocean to our west.

(1) Rising superpowers always believe they have the key to the riddle of history. They believe that history is about to reveal that their system is the best, and their elites are extremely unwilling to take even the best-intentioned advice from abroad on how to constitute their internal arrangements. They in fact believe that other countries should learn from them, and adopt their systems—even though, as rising superpowers, they do not or do not yet seek to impose their systems on others.

(2) Rising superpowers have a profound dislike of potentially-hostile bases near their borders, and a profound dislike of other powers’ interfering in what they think manifest destiny has decreed is their sphere of influence. They make their neighbors nervous.

(3) Rising superpowers almost always have territoria irridentia: regions that they believe ought to be under their control, and that only malign manipulations by other powers and historical accidents have left outside their current borders.

(4) Rising superpowers are overwhelmingly focused on making the world economy and society work for them and for their ruling classes.

And (5) managing your relationship with a rising superpower, doing as much as possible to align its and its elite’s core interests with yours, and then appeasing those core interests that cannot be so aligned, is your most important foreign-policy task and objective not just for one but for many generations.

I am, of course, speaking about Henry John Temple and [John Russell2, the third Viscount Palmerston and the first Earl Russell. Lord Palmerston and Lord John Russell were the British Whig mid-nineteenth century grandees who led the multi-generational pivot of the Whig, the Tory, and the subsequent Liberal administrations with respect to the British Victorian-era grand-strategic problem of how to deal with the rising superpower across the great ocean to the west that was the United States.

The mid-nineteenth century United States of America was a rising superpower, aggressively confident of its system. It was, in the words of John Quincy Adams: “the well-wisher to the freedom and independence of all… the champion and vindicator only of her own… [advancing the general cause] by the… sympathy of her example.” Great Britain had nothing to teach, the Americans thought, but rather should admire and learn.

What the rising superpower of the United States would not countenance was hostile bases, or perhaps I should say additional potentially-important hostile bases, anywhere near her borders. The Monroe Doctrine was evolved long before the United States could even begin to enforce it. And the United States certainly did not seek formal empire over Latin America. But it would react aggressively and with hostility to any European power’s intrusion into Latin America. And it would, eventually, seek, in Woodrow Wilson’s words, “to teach the South American republics to elect good men.”

And what rankled the United States in the mid-nineteenth century was the territoria irridentia of Canada—especially British Columbia: “54°40’ or fight!” was the American position on where the northern border of America’s claim to the Oregon Territory should be set. Plus there was the rest of Canada.

But the United States could be guided, and could be very comfortable in a British navy-protected free-trade political-economic order that allowed it to prosper and grow. And the interests of it and its elite could be brought into alignment, in at least major outlines, to the essential strategic interests of Imperial Britain.

In the 1840s, therefore, the Whig government of Lord Palmerston and Lord John Russell did a very unusual thing. The typical way for Victorian Britain to settle a dispute like that of the 1840s over the Oregon Territory would have been to adopt the negotiating strategy of sending a Canadian army and the British navy to burn down the negotiating counterparty’s capital, followed by a dictation of terms. Britain did not do that. It compromised: agreeing to an extension of the latitude line that had previously defined the southern border of Alberta, Saskatchewan, and Manitoba.

In the 1860s, therefore, the Whig government of the Earl Russell and Lord Palmerston did a very unusual thing. Usually Victorian Britain’s commitment to freedom of trade and the seas was lexicographically preferred to all other principles. One could argue over the rights and wrongs of addicting millions of China’s citizens to opiates through the drug trade. But interfering with commerce by seizing and destroying the property of British merchants—even property in the form of opiates—was beyond the pale, and cause for war. Fight first for free trade and protection of property, and deal with the other equities later. But that was not the line taken by the Whig government with respect to the cotton trade during the U.S. Civil War. The line was drawn not at interfering with British ships carrying cotton but at taking Confederate diplomats off of British ships.

And, thereafter, successive British governments, investors, noblemen and noblewomen, merchants, and manufacturers strove mightily to bind the United States to Britain. Material common economic interests and mutual economic interdependence grew. Conflicting political ideal interests fell away. Back in 1775 a core political interest of the United States-to-be was the conquest of Quebec, and Benedict Arnold’s army was sent north. Back in 1812—and for decades thereafter—a core political interest of the United States under James Madison was the conquest of Quebec, and fleets were duly built on the Great Lakes and then duly sunk by Canadian cannon. A very powerful ideal interest back then.

But what U.S. citizen today feels a pain at the thought that Toronto lies north of the U.S. border? I know I do. I look around this room. and it is painful to me that the Rt. Hon. Chrystia Freeland is Her Canadian Majesty’s Minister of International Trade in Ottawa. I wish she were not in Ottawa but in Washington. I wish she were the eloquent and influential Senator Chrystia Freeland (D-South-Central Ontario). U.S. politics would be much healthier were that the case. But I am unusual. And I digress…

The binding of the rising superpower back in the nineteenth century had many policy and non-policy parts, not all of them conscious or deliberate. but whether it was Cecil Rhodes’s offering free acculturation at Oxford to young members of the American elite, British investors entrusting the House of Morgan with their money, the Dukes of Marlborough offering their sons to daughters of plutocrats Consuelo Vanderbilt and Jenny Jerome, it was effective—so effective that just when Nazi Germany attacked the Franco-British army in 1940 the Prime Minister of Britain was a man who, as a natural-born citizen of the United States, was also perfectly well-qualified to be the American president.

This alignment of American interests and values to British took a long time—from 1850 and 1910: economic ties, cultural ties, plus political ties of mutual deference where strategic issues were at stake. But, as a result, by 1910 Americans by and large perceived Britain as their friend, and the British Empire as by and large a force for good in the world, and its interests as closely-aligned with theirs. This is in striking contrast to how Imperial Britain was perceived in 1850: as the cruel and corrupt ex-colonial power, the heartless aristocrats who had just starved a quarter of all Irishmen to death.

This mattered a lot. And this mattered a lot not just for the wave of prosperity produced up through 1913 by the coming of the Second Industrial Revolution and the First Great Globalization.

This mattered a lot for grand-geostrategic reasons as well. This meant that when Britain got into trouble in the twentieth century—as it did, first with Wilhelm II Hohenzollern and his ministers, second with Adolf Hitler, and third with Josef Stalin and his successors—it had wired aces as its hole cards in the poker game of seven-card stud that is international relations. The willingness of the United States to send Pershing and his army Over There, to risk war with and then to fight Hitler, and to move U.S. tanks from Ft. Hood, TX, to the Fulda Gap. These were all powerfully motivated by America's affinity with Britain, its geostrategic causes, and its security. And these allowed Britain to punch far above its economic and military weight from 1917 on.

How does this apply to the TPP?

Just like Lord John Russell and Lord Palmerston in the 1840s and thereafter, we face a rising superpower across the ocean to our west. There is a good chance that China is now on the same path to world preeminence that America walked 130 years ago. Alexis de Tocqueville could project before the Civil War that the U.S. and Russia were likely to become twentieth-century superpowers. We can project today that at least one of India and China--perhaps both--will become late-twenty first century superpowers. We have an interest in building ties of affinity now.

My old Harvard professor Benjamin Friedman’s The Moral Consequences of Economic Growth argues that the wiring of human brains is such that the process of becoming richer relative to the reference point provided by our parents and their peers has a large number of beneficial moral as well as material effects. Modern societies are like bicycles: they move forward, or they fall over. Come 2047 and again in 2071 and in the years after 2075, the NATO powers are going to need China and China’s elite to believe and to have material and ideal interests broadly aligned with those of NATO. Thus there is nothing more dangerous for America's future national security and nothing more destructive to America's future prosperity than for Chinese schoolchildren to be taught in 2047 and 2071 and 2075 that America tried to keep the Chinese as poor as possible for as long as possible. There is little more dangerous to the NATO powers than a Chinese elite whose values and interests are not broadly consonant with those of America. And there is nothing more conducive to aligning the interests of China and its elite with those of the NATO powers than a China which is (a) growing richer, (b) increasingly entranced by the economic and cultural successes of North Atlantic civilization, (c) treated with respect, and (d) incentivized to strive for victory not in negative-sum military power but in positive-sum economic and technological games of international relations.

The big geostrategic danger, I think, is of a Wilhelmine China. Wilhelmine Germany was a rising economic superpower ruled by a class that had lost its social role. Faced with internal dissent, it contemplated busying giddy minds with foreign quarrels as a way to distract popular attention from internal problems and debates. Needless to say, this ended in total disaster for generations of Germans. But is China’s East China Sea Air Defense Identification Zone and its adventurism in the South China Sea an attempt to cheaply accomplish the primacy-of-internal-politics foreign-affairs strategy that Shakespeare’s Henry IV Lancaster recommended on his deathbed to his son the future Henry V? And, if so, how to lead China’s elite to the realization that, in the words of the computer in the movie “War Games”: “The way to win this game is not to play”?

This is the broadest context in which the North Atlantic—and Asian-Pacific Rim, and Australasian—discussion of the TPP ought to be set.

3360 words


Wait: Maybe Europeans are as Rich as Americans

Yves here. I’ve gotten similar arguments from many Europeans: that when you adjust nominally higher American incomes for how much we spend from our own pockets on healthcare plus the longer hours we work, we aren’t better off. And if you attribute a cost to stress (which you can also see in the level of prescriptions of psychoactive drugs here), it’s not hard to push this thesis further. By Steve Roth. Originally published at Angry Bear ’ve pointed out multiple times that despite Europe’s big, supposedly growth-strangling governments, Europe and the U.S. have grown at the same rate over the last 45 years. Here’s the latest data from the OECD, through 2014 (click for larger): European v. US growth And here’s the spreadsheet. Have your way with it. More discussion and explanation in a previous post. You can cherry-pick brief periods along the bottom diagonal to support any argument you like. But between 1970 and 2014, U.S. real GDP per capita grew 117%. The EU15 grew 115%. (Rounding explains the 1% difference shown above.) Statistically, we call that “the same.” Which brought me back to a question that’s been nagging me for years: why hasn’t Europe caught up? Basic growth theory tells us it should (convergence, Solow, all that). And it did, very impressively, in the thirty years after World War II (interestingly, this during a period when the world lay in tatters, and the U.S. utterly dominated global manufacturing, trade, and commerce). But then in the mid 70s Europe stopped catching up. U.S. GDP per capita today (2014) is $50,620. For Europe it’s $38,870 — only 77% of the U.S. figure, roughly what it’s been since the 70s. What’s with that? Small-government advocates will suggest that the big European governments built after World War II are the culprit; they finally started to bite in the 70s. But then, again: why has Europe grown just as fast as the U.S. since the 70s? It’s a conundrum. I’m thinking the small-government types might be right: it’s about government. But they’ve got the wrong explanation. Think about how GDP is measured. Private-sector output is estimated by spending on final goods and services in the market. But that doesn’t work for government goods, because they aren’t sold in the market. So they’re estimated based on the cost of producing and delivering them. Small-government advocates frequently make this point about the measurement of government production. But they then jump immediately to a foregone conclusion: that the value of government goods are services are being overestimated by this method. (You can see Tyler Cowen doing it here.) That makes no sense to me. What would private output look like if it was measured at the cost of production? Way lower. Is government really so inefficient that its production costs are higher than its output? It’s hard to say, but that seems wildly improbable, strikes me as a pure leap of faith, completely contrary to reasonable Bayesian priors about input versus output in production. Imagine, rather, that the cost-of-production estimation method is underestimating the value of government goods — just as it would (wildly) underestimate private goods if they were measured that way. Now do the math: EU built out governments encompassing about 40% of GDP. The U.S. is about 25%. Think: America’s insanely expensive health care and higher education, much or most of it measured at market prices for GDP purposes, not cost of production as in Europe. Add in our extraordinary spending on financial services — spending which is far lower in Europe, with its more-comprehensive government pension and retirement programs. Feel free to add to the list. All those European government services are measured at cost of production, while equivalent U.S. services are measured at (much higher) market cost. Is it any wonder that U.S. GDP looks higher? I’d be delighted to hear from readers about any measures or studies that have managed to quantify this difficult conundrum. What’s the value or “utility” of government services, designated in dollars (or whatever)? Update: I can’t believe I failed to mention what’s probably the primary cause of the US/EU differential: Europeans work less. A lot less. Like four or six weeks a year less. They’ve chosen free time with their families, time to do things they love with people they love, over square footage and cubic inches. Got family values? I can’t believe I forgot to mention it, because I’ve written about it at least half a dozen times. If Europeans worked as many hours as Americans, their GDP figures would still be roughly 14% below the U.S. But mis-measurement of government output, plus several other GDP-measurement discrepancies across countries, could easily explain that.

Is Economic Success Inherited?

This is by Abdul Alasaad:

Is Financial Success a Product of Inherited Genes?, INET: How much does a family’s wealth determine a child’s financial prospects? ... In his ... essay, Defending the One Percent, Gerg Mankiw links the correlation between people’s earnings with those of their parents to genetic factors. ...
Is Mankiw right to link this strong relationship to genetic factors? Well,.. four economists, in an NBER working paper, compared the wealth of adoptive children to the wealth of their adoptive and biological parents. ...
The relationship between the wealth ranking of adoptive children and with those of their adoptive parents is strikingly positive and almost as strong as the relationship between parents and their biological children...
More conclusively..., a child’s wealth is more strongly correlated with the wealth of their adoptive parents than to the wealth of their biological parents. Nurture, when it comes to wealth, is far more important than nature.
But overall, who had a higher net wealth at the age of 44 prior to any inheritance? Biological children or adopted ones? ... It turns out that the biological children had in fact accumulated more net worth; but by a very small, and almost irrelevant, margin. ...
Equally interesting, the researchers study the variation in attainment of education levels between adopted children and biological ones. If genetic factors matter more than access to opportunity, then biological children of affluent parents must attain higher levels of education than their adopted counterparts. Is this true? Well, The data suggest otherwise. ...
Wealth, like most things in life, has more to do with environmental factors than genetic ones. ...

Merkels Propagandamaschine Eine Kolumne von Georg Diez



Jeder Eine Kolumne von , der von der „Rettung“ Griechenlands spricht, richtet moralisch. An solcher Berichterstattung zeigt sich, wie manipulativ ein Journalismus agiert, der vor allem von deutschen Interessen handelt.

Propaganda, sagt Edward Bernays, der den Begriff geprägt hat, ist die Reduktion der komplexen Wirklichkeit auf einige wenige, leicht zu verstehende Erklärungen, und es ist dabei letztlich egal, ob diese Erklärungen auch stimmen.


Sein Klassiker „Propaganda“ erschien 1928, weit vor Fernsehen und Internet, er ist mehr Handlungsanweisung für die Mächtigen als Kritik an der Manipulation der Massen – gerade deshalb lohnt es sich heute, ihn mal wieder zu lesen.

Denn in seinem Sinn ist zum Beispiel jeder Artikel, der die Eurokrise darauf reduziert, dass Merkel oder Schäuble oder Brüssel oder sonst irgendjemand Griechenland „rettet“, nichts anderes als Propaganda.

„Merkel rettet die Banken“

Seit Jahren ist „Rettung“ das Wort, das viele Journalisten benutzen, um die Geschichte dieser Krise zu erzählen: Mit einem Wort wird etabliert, wer etwas tut und wer nichts tut, wer aktiv ist und wer passiv, wer am Abgrund steht und wer mit der helfenden Hand herbeieilt.


Mit einem Wort werden Schuld und Abhängigkeit hergestellt, mit einem Wort werden Dankbarkeit und Versagen festgelegt, mit einem Wort wird moralisch gerichtet – die Analyse kommt nicht mehr hinterher, wenn erst mal die emotionale Ebene erreicht ist.


Der Retter ist ja im Recht, das suggeriert dieses Wort, er ist im Besitz der Wahrheit, er hat das Gute auf seiner Seite, er handelt aus höheren Motiven – „Rettung“ ist deshalb ein Wort, das im Politischen an sich oder im politischen Journalismus als solchem nichts verloren hat, denn es verschleiert die Motive und Interessen, aus denen Politik besteht.

Ich habe zum Beispiel noch keine Schlagzeile gelesen, die lautete: „Merkel rettet die Banken“ – dabei wäre auch das eine sehr plausible Verkürzung dessen, was in Europa spätestens seit 2010 passiert ist.

Und auch diese Schlagzeile fehlt noch: „EU und IWF planen Staatsstreich in Griechenland“. Dabei kann man die Eurokrise durchaus so zusammenfassen: Wenn es darum geht, Griechenland in die Knie zu zwingen, und so wird das immer intoniert, nimmt man ein mögliches Scheitern der griechischen Regierung gern in Kauf.

Primär wird der Kapitalismus gerettet

„Es ist ein erstaunliches Spektakel“, schreibt etwa Ambrose Evans-Pritchard, ein „Burke-Konservativer“, wie er sich selbst nennt, kein Linker – die Europäische Zentralbank und der IWF, meint er, würden „wie rasend auf eine gewählte Regierung einprügeln, die nicht das tut, was sie wollen“.

Auch Jürgen Habermas hat in dieser Woche noch mal auf das grundlegende Demokratiedefizit der EU hingewiesen – es werden in Griechenland nicht die europäischen Werte oder die demokratischen Ideale oder gar die griechischen Bürger „gerettet“, es wird primär ein Kapitalismus gerettet, der Stabilität und Sicherheit braucht.

Die Europäische Zentralbank hat schon mal vorgemacht, wie das geht, sie schickte im August 2011 geheime Briefe an die spanische und italienische Regierung, in denen sie Änderungen an Gesetzen verlangte und damit in die inneren Angelegenheiten dieser Länder eingriff.

Merkwürdigerweise findet man Texte mit solchen Information aber vor allem in amerikanischen und englischen Medien – der durchschnittliche deutsche Leitartikler findet eh, dass die Griechen – gegen jeden ökonomischen Sachverstand – noch mehr sparen müssen, sieben fette Jahre seien genug.

Dass die EU damit ihr Wohlstandsversprechen bricht, eine der wesentlichen Grundlagen und Existenzberechtigung überhaupt der EU, dass es also aufseiten der EU ein deutliches Versagen gibt, das angesprochen werden sollte, das fehlt in der Geschichte von der „Rettung“ Griechenlands.

Politikberichterstattung im Geist der Seifenoper

Stattdessen wird immer wieder neu auf den Showdown hingeschrieben, was nur die Krisenrhetorik der „Retter“ bedient, die den permanenten Notstand brauchen, um ihre drastischen Maßnahmen zu legitimieren – der Journalismus engagiert sich in einer Eskalationsdramaturgie, die in der Atemlosigkeit keinen Platz zum Nachdenken lässt.

Und gleichzeitig wird im „Tagesspiegel“ über Schäubles blaue Augen geschrieben, die nicht lügen können, und in der „Welt“ über die Ehefrau, die Tsipras erst zu dem Sturkopf gemacht hat, der er aus deutscher Sicht sein muss – es ist eine Politikberichterstattung im Geist der Seifenoper, die letztlich nur dazu dient, die zugrunde liegenden ökonomischen Probleme zu verhüllen.

Komplizenschaft zwischen Politik und Medien

„Alles Lügen?“, fragt die „Zeit“ in ihrer Titelgeschichte von dieser Woche, eine selbstkritische Reflexion über den Druck auf die Medien in den letzten Jahren und auf die Fehler, die gemacht wurden – Irakkrieg 2003 und Finanzkrise 2008 sind zwei Beispiele, aber „nun haben die Redaktionen aus ihren Fehlern gelernt“.

Aber ist nicht die Griechenland-Berichterstattung genauso ein Beispiel dafür, wie manipulativ und einseitig ein Journalismus agiert, der vor allem von deutschen Interessen handelt und eine deutsche Sicht der Dinge verbreitet, die weit entfernt ist von dem, was in anderen europäischen Ländern geschrieben und gedacht wird?

So sieht das jedenfalls Ambrose Evans-Pritchard, der im britischen „Telegraph“ die griechische Schuldenkrise zum „Irakkrieg der Finanzen“ erklärt – er meint damit auch die Komplizenschaft zwischen Politik und Medien, die in der vergangenen Woche einen „Bank-Run“ regelrecht beschworen hätten.

„Die bewusste und intelligente Manipulation des kollektiven Verhaltens und der Meinungen der Massen ist ein wichtiges Element in der demokratischen Gesellschaft“, schreibt Edward Bernays. „Es ist eine unsichtbare Regierung, die diesen verborgenen gesellschaftlichen Mechanismus manipuliert, sie ist die eigentliche Herrschaftsmacht in unserem Land.“

Es ist eine Regierung, die niemand gewählt hat und die niemand kontrolliert.

From ZIRP to NIRP: Virtues of Germany vs. the Vices of Greece; What About „Speece“ and Gold?

Virtues of Germany vs. the Vices of Greece

At the heart of the constant bailout bickering in Europe is a fundamental, but seriously misguided notion that a battle is underway between the virtuous and fiscally responsible Germans and the irresponsible Greeks, Spaniards, and Portuguese.

In this incorrect view, the Spaniards have begun to see the light, but the Greeks need a serious lesson in morality.

If we step back and actually assign blame, we can find plenty of blame to go around.

"Speece" (my term for the Southern eurozone deficit countries of Spain, Greece, Portugal etc.) made many mistakes, but so did Germany.

It's logically impossible to believe "Speece" was a horrendously imprudent borrower, while simultaneously holding the view that Germany was a prudent lender.

More importantly, neither imprudent borrowing nor imprudent lending is at the heart of the eurozone problem.

Background Notes

Some snips from this post are from an email from Michael Pettis at Global Source Partners. Pettis' email contained a 32 page PDF that I will attempt to condense down to a couple pages, while adding a few pages of my own on topics he missed or went over lightly.

Except where noted, anything below in blockquotes is from Michael Pettis. Emphasis throughout is mine.

In regards to comments from Pettis, he says "As my regular readers know, I generally refer to the two different groups of creditor and debtor countries as 'Germany' and 'Spain', the former for obvious reasons and the latter because I was born and grew up there, and it is the country I know best.

Thus any comment from Pettis on "Spain" may mean "any eurozone debtor" and any comment on "Germany" may mean "any eurozone creditor".

I occasionally use the term "Speece" in the same way.

In context, sometimes Pettis says "Spain" and means "Spain". It's usually clear.

Moral Battle Update 

On February 27, the German Bundestag approved Greece's bailout extension request, but acrimony remains high.

For example, the Financial Times noted Germany’s biggest selling newspaper Bild attacked the Bundestag's decision to extend the bailout, with a front page on headline “Bild readers say No – no more billions for Greece.”

In the Bundestag, Klaus-Peter Willsch, a CDU legislator and longstanding bailout critic, launched a personal attack on the Greek prime minister and finance minister.

Look at [Alexis] Tsipras, look at [Yanis] Varoufakis, would you buy a used car from them? If the answer is no, then vote no today,” said Willsch.

And during the intense negotiations between Greece and Germany ahead of this vote, the parliamentary caucus leader of German Chancellor Angela Merkel’s Christian Democrats, Volker Kauder, told reporters "Germany bears no responsibility for what happened in Greece. The new prime minister must recognize that."

No Responsibility?

Does Kauder really believe Germany has "no" responsibility? Does finance minister Wolfgang Schäuble who has made similar-sounding statements believe that?

Whether or not Kauder and Schäuble believe their statements, people hear them again and again. Over time, such statements become conventional wisdom.

From Pettis ...

Nationalist Dreams
European nationalists have successfully convinced us, against all logic, that the European crisis is a conflict among nations, and not among economic sectors.

While distortions in the savings rate are at the root of the European crisis, many if not most analysts have failed to understand why. Until now, an awful lot of Europeans have understood the crisis primarily in terms of differences in national character, economic virtue, and as a moral struggle between prudence and irresponsibility.

This interpretation is intuitively appealing but it is almost wholly incorrect. And because the cost of saving Europe is debt forgiveness, Europe must decide if this is a cost worth paying (and I think it is).

Yet, as long as the European crisis is seen as a struggle between the prudent countries and the irresponsible countries, it is extremely unlikely that Europeans will be willing to pay the cost.
Savings Rate Distortions
From 2000-04 Spain ran stable current account deficits of roughly 3-4% of GDP, more or less double the average of the previous decade. Germany, after a decade of current account deficits of roughly 1% of GDP, began the century with slightly larger deficits, but this balanced to zero by 2002, after which Germany ran steady surpluses of 2% for the next two years.

Everything changed around 2005. Germany’s surplus jumped sharply to nearly 5% of GDP and averaged 6% for the next four years. The opposite happened to Spain. From 2005 until 2009 Spain’s current account deficit roughly doubled again from its 3-4% average during the previous five years.

The numbers are not directly comparable, of course, but during those four years Spain effectively absorbed capital inflows above its “normal” absorption rate equal to an astonishing 21-22% of GDP from 2005 to 2009, and of 31- 32% of GDP from 2000 to 2009.

It wasn't just Spain. In the 2005-09 period, a number of peripheral European countries experienced net inflows of similar magnitude.

In principle, it isn’t obvious which way causality ran between capital account inflows and current account deficits (the two must always balance to zero).

To put it differently, German money might have been “pushed” into these countries, as the “blame Germany” crew has it, or it might have been “pulled” in, by the need to finance their spending orgies, as the “blame anyone but Germany” crew insist. For those who prefer to think in more precise terms, Germany either created or accommodated the collapse in Spanish savings relative to Spanish investment.

If it were the latter case, however, it would be an astonishing coincidence that so many countries decided to embark on consumption sprees at exactly the same time.
Push vs. Pull

I think we can look at push vs. pull another way. To pull credit, one bids up the interest rate. To push credit, one pushes the interest rates down.

From the push-pull interest rate point of view, the "blame Germany" crowd has the better argument.

Arguments Against Debt Forgiveness

Pettis provides a number of widely used arguments against debt forgiveness.

The arguments boil down to a couple of primary beliefs. Most have heard one or both of the following.

  1. The German people provided Spain with real, hard-earned resources which Spaniards misused. It is not fair or honorable that Spain punish the German people for its generosity. To forgive debt would create a moral hazard.
  3. Spain had a real choice, and it chose to spend money wantonly on consumer frivolities and worthless investment projects. Had Spaniards acted more like Germans and refrained from excessive consumption — the result of a flawed national character trait — it would not have suffered from speculative stock and real estate market bubbles, wasted investment and, above all, an unsustainable consumption boom and a collapse in savings. It is unfortunate that ordinary Spaniards must suffer for the venality of its leaders, but ultimately Spain is responsible.
Question of Choice

Was there really a choice? Did Speece make these mistakes acting alone or because of  "venality of its leaders".

Pettis answers ...

Blaming Nations
Because German capital flows to Spain ensured that Spanish inflation exceeded German inflation, lending rates that may have been "reasonable" in Germany were extremely low in Spain, perhaps even negative in real terms. With German, Spanish, and other banks offering nearly unlimited amounts of extremely cheap credit to all takers in Spain, the fact that some of these borrowers were terribly irresponsible was not a Spanish "choice".

Couldn't Spain have refused to accept the cheap credit, and so would not have suffered from speculative market excesses, poor investment, and the collapse in the savings rate?
Not really. Pettis explains ...
"There is no such a decision-maker as 'Spain'. As long as a country has a large number of individuals, households, and business entities, it does not require uniform irresponsibility, or even majority irresponsibility, for the economy to misuse unlimited credit at excessively low interest rates. The experience of Germany after 1871 suggests that it is nearly impossible to prevent a massive capital inflow form destabilizing domestic markets."

As German money poured into Spain, with Spain importing capital equal to 10% of GDP at its peak, the massive capital inflows and declining interest rates ignited asset price bubbles.
Pro-Cyclical Feedback Loops

Spain could not stop these pro-cyclical feedback loops of massive proportion because Spain did not have control over its own interest rate policy or currency.

Instead, the ECB had an interest rate policy best described in my opinion as "one size fits Germany".

The bubble-blowing feedback loop fed on itself until it blew up. Who is really to blame for that?


No discussion of eurozone problems would be complete without a discussion of Target2, an abomination created by the eurozone founders and one of the fundamental flaws of the euro.

Target2 stands for Trans-European Automated Real-time Gross Settlement System.

It is a reflection of capital flight from the "Club-Med" countries in Southern Europe (Greece, Spain, and Italy) to banks in Northern Europe.

Pater Tenebrarum at the Acting Man blog provides this easy to understand example: "Spain imports German goods, but no Spanish goods or capital have been acquired by any private party in Germany in return. The only thing that has been 'acquired' is an IOU issued by the Spanish commercial bank to the Bank of Spain in return for funding the payment."

Also, if people in "Speece" no longer trust their banks, they pull their deposits and park them elsewhere.

Channel for Capital Flight

PIMCO explains Target2 as a Channel for Capital Flight.
​The EU’s loans to Greece, Ireland and Portugal are just the tip of the iceberg of a fledgling transfer system that is creeping into the eurozone via the back door. A far bigger and implicit subsidy is growing beneath the surface in the form of TARGET2.

When the European Central Bank (ECB) creates money, as it currently is doing in grand style, it must end up somewhere. The allocation of TARGET2 balances among the seventeen national central banks, which together with the ECB make up the Eurosystem, reflects where the market allocates the money created by the ECB. The fact that the Bundesbank has a large TARGET2 claim (asset) on the Eurosystem, while national central banks in southern Europe and Ireland together have an equally large TARGET2 liability, simply reflects that a lot of the ECB’s newly created money has ended up in Germany. Why? Because of capital flight.

Countries in southern Europe generated persistent current account deficits since joining the euro in 1999, some of them large. A current account deficit means a country spends more in total than it earns. That extra spending is financed by borrowing from abroad. The source for such borrowing comes from a current account surplus country, like Germany. Since the euro eliminated exchange rate risk among its member states, Germany has invested a substantial portion of its savings in Europe’s current account deficit countries. Some of those savings are now returning home. That’s the capital flight.

Enter the ECB. The ECB stepped into the void left by foreign investors pulling their savings out of these current account deficit countries by lending their banks more money. TARGET2 balances thus reflect intra-Eurosystem credits among the national central banks sharing the euro. When large capital flight to Germany occurred before the euro’s introduction, the deutschemark would appreciate against other European currencies. While pegged against the deutschemark, these exchange rates were still flexible. That flexibility disappeared with the euro.

When capital flight occurs today, the Bundesbank effectively ends up with loans to the other national central banks that are reflected in the TARGET2 claims on the Eurosystem.
Target2 Imbalances

Chart courtesy of Euro Crisis Monitor.

As of January 15, 2015, the Target2 numbers look like this, in billions of euros:

Germany 515.266

Key Target2 Numbers

  • Germany has a Target2 surplus of €515 billion.
  • Greece has a target2 deficit of €76 billion.
  • Spain has a target2 deficit of €192 billion.
  • Italy has a target2 deficit of €164 billion.

The ECB treats all of these surpluses and deficits as if they were equal and as if they don't matter. Clearly they are not equal, and they do matter.

Role of Attitudes

It's not entirely true that attitudes played no role in this mess. Germans tend to view things quite differently because of their experience with hyperinflation in the 1920s.

Today, socialists rule France, Greece, Spain and other countries. Greece has a history of defaults.

To completely dismiss such items is wrong. But who bears responsibility? The Germans, the Greeks, the Spaniards? Speece?

The answer is the eurozone founders and the eurozone aggregate members.

Greece lied to get into the eurozone. But every country knew Greece lied. If they didn't, they should have. And if Germany knew Greece lied, who gets the bigger share of the blame?

More fundamentally, the eurozone founders knew full well there were serious productivity differences, work rule differences, pension differences, etc., etc., between countries. The eurozone founders mistakenly assumed that all the countries would get together and solve these issues. 

Oops. That is damn near impossible now because rule changes require consent of every eurozone country. The more countries that are added, the more difficult it is to get rule changes.

Currently a mass of rule changes are sorely needed on agricultural issues, work issues, pension issues, and literally dozens of issues. Any country can block reform.

Gold Standard

Of all the laughable analogies made about the euro, at the top of the list is the notion the euro acts likes the gold standard. One can find many writers making such claims.

For example, please consider Actually, There Is A Gold Standard Today, And It's Causing An Economic Catastrophe.

The post is fatally flawed, yet it does reflect conventional wisdom.

Here is a short rebuttal: Only in the superficial sense, that countries cannot debase their currency in isolation, does the euro remotely resemble a gold standard. On a practical and far more important basis, Target2 and the common interest rate policy are the opposites of what would happen on a gold standard.

Prior to Nixon closing the gold exchange window, countries running perpetual currency account deficits would see an outflow of gold they would eventually need to do something about.

In the eurozone, the ECB set interest rate policy (primarily for the benefit of Germany) and Target2 said the deficits of Speece do not matter.

Under a gold standard, no one would have lent his own hard-earned gold to Speece, without much higher interest rates and good collateral to secure the loan. This of course would have dampened appetite for borrowing.

Simply put, the eurozone setup was the exact opposite of what would have happened under a gold standard.

Still No Enforcement Mechanism, Anywhere

Because there were no trade imbalance enforcement mechanisms, Speece imbalances grew until they blew up. And until they blew up, the IMF had nothing but praise for Spain! And every step of the way, the IMF underestimated the problems Greece faced.

We are headed into the third Greek bailout, and the IMF remains clueless about Greece's ability to pay back "bailout" money.

Worse yet, there still is no "enforcement" mechanism anywhere in the world, and the structure of the euro is such that imbalances in Europe are even harder to fix than elsewhere.


In the US, we see chronic trade imbalances with China, Japan, and oil producers. We also see constant bickering as to whether or not to label China a "currency manipulator".

Every country is manipulating currency now, one way or another. China does so with pegs, most countries manipulate via interest rate policy.

The mad race to ZIRP has now gone to NIRP. Zero interest rate policy has morphed into negative interest rate policy in a global beggar-thy-neighbor scheme.

EFSF and ESM - Short Term Stabilizing, Long Term Destabilizing

The European Financial Stability System (EFSF), was created  in 2010 as a "temporary" crisis resolution mechanism. The EFSF provided financial assistance to Ireland, Portugal and Greece.

The ESM is supposedly a "permanent" crisis resolution mechanism. The ESM has provided loans to Spain and Cyprus.

Risk is shared by all eurozone member states in proportion to their share in the paid-up capital of the European Central Bank. That risk sharing is in clear violation of Maastricht Treaty no-bailout provisions, but few care about rules in time of crisis.

The problem with "risk sharing" is that every county is partially responsible for problems elsewhere. In short, Spain is partially responsible for Greece, and vice versa. This can lead to cascade effects if a country defaults on bailout obligation.

Dr. Eric Dor, director of IESEG School of Management in Lille, has an update on exposure to Greek debt liabilities.

The details are interesting.

IESEGBilateral loansGuarantees on the borrowings of EFSF to fund its loansImplicit share of TARGET2 claims of the EurosystemImplicit share in the SMP holdings of bonds by the EurosystemTotal

The above table is from Exposure of European Countries to Greece by Dr. Eric Dor, IESEG School of Management.

Note: The above table was produced at a different time than the Target2 balances that preceded it. There may be slight differences.

Spain which is in its own ESM bailout agreement is supposedly liable for €32.744 of Greek exposure. How is that going to work, besides not?

Some disagree (or more likely say they disagree because it suits their short-term needs), but these bailout agreements as structured are in clear violation of the Maastricht Treaty. At some point, this will come back to haunt those who dreamed up those schemes.

Problem is Not Virtue vs. Vice

Let's return to a statement Pettis made much earlier: To the extent that the European crisis is seen as a struggle between the prudent countries and the irresponsible countries, it is extremely unlikely that Europeans will be willing to pay the cost.

Blame Assignment

Hopefully it is now clear the problem is not virtue vs. vice, but something far more complex. With that in mind, the question of the day is "how do we assign blame for problems in Speece?" In rough order, I propose ....

  1. No enforcement mechanisms
  2. ECB
  3. Target2
  4. Eurozone founders and eurozone rules
  5. Eurozone member states ignoring rules
  6. Attitudes

Most have attitudes at the top. I have attitudes at the bottom. I suppose one could summarize points 1-5 simply as the "eurozone flaws" or the "euro" but each is worth discussing separately.

Debt Dynamics

Pettis says "Even if the question of who is to blame, Greece or Germany, were an important one, the answer would not change the debt dynamics."

True enough.

In the end, Greece will not pay back, what cannot be paid back. Indeed, two haircuts have already been taken. The bickering now is whether or not there will be another bailout, and still further haircuts.

How do we know Greece cannot pay back the existing debt? The market tells us so. Ironically, by the time the market makes it clear there is a huge problem (yields soar for example), it's too late to do much of anything but assign costs.

Said Pettis, "My friend Hans Humes, from Greylock Capital, has been involved in more sovereign debt restructurings than I can remember, and he once told me with weary disgust that while it is usually pretty easy to guess what the ultimate deal will look like within the first few days of negotiation, it still takes months or even years of squabbling and bitter arguing before getting there. We cannot forget however that each month of delay will be far more costly to Greece and her people than we might at first assume."

Rise of Fringe Parties

Curiously, one of the biggest finger-pointers in this mess now is Spain. The Financial Times talked about it in Spain Keeps Hawkish Eye on Greece as Southern Solidarity Crumbles.

"In its fear of Podemos, the Spanish equivalent of Syriza, and its determination to be one of the
'virtuous' countries, it strikes me that Madrid is probably moving in the wrong direction economically. Ultimately, by tying itself even more tightly to the interests of the creditors, Rajoy and his associates are only making the electoral prospects for Podemos all the brighter," said Pettis.

Solidarity Where?

On Monday March 2, acrimony took another huge step forward as Greek premier Alexis Tsipras accused Spain and Portugal of sabotaging negotiations.
“We found opposing us an axis of powers ... led by the governments of Spain and Portugal which, for obvious political reasons, attempted to lead the entire negotiations to the brink,” Tsipras told party members on Saturday.

Their plan was, and is, to wear down, topple or bring our government to unconditional surrender before our work begins to bear fruit and before the Greek example affects other countries… And mainly before the elections in Spain.
Prime minister Rajoy responded "We are not responsible for the frustration generated by the radical Greek left that promised the Greeks something it couldn’t deliver on."

Spanish Prime Minsiter Mariano Rajoy is making a big mistake. Spain can use debt relief. And the citizens of Spain want debt relief.
By taking a hard stance in favor of Berlin, Rajoy adds fuel to the rise of Podemos. Siding with Germany is the wrong thing to do if Rajoy wants to win reelection.

Playing with Fire

Tsipras is a close friend and political ally of Pablo Iglesias, the former political science lecturer who founded Spain’s anti-establishment Podemos movement.

Podemos is currently in the lead in Spanish polls. Elections are later this year.

Rise of Extreme Parties

Check out the rise of "extreme parties".

  • Syriza in Greece
  • Golden Dawn in Greece
  • Podemos in Spain
  • Five Star Movement in Italy
  • National Front in France
  • AfD in Germany
  • New Fins in Finland

In that group there are leftwing and rightwing parties, but all have one thing in common: They are sick of something. Spain is supposedly in recovery. What are Spaniards upset about? Greeks?

Spanish Unemployment

Spanish Youth Unemployment

Greek Unemployment

Greek Youth Unemployment

Unemployment is a huge problem. Growth alone will not cure this problem. Both Spain and Greece are growing now.

High unemployment rates in Speece will remain for a long time unless there is debt forgiveness or Germany turns its current account surplus into a deficit for the express benefit of Speece.

Speece cannot become more like Germany, unless Germany becomes less like Germany and more like Speece.

Third Bailout or Grexit

I believe a third bailout and a third restructuring of Greek debt is necessary (See
Third Greek Bailout? Another €53.8 Billion Needed? Primary Account Surplus Revisited).

Will Greece go along? Slim chance, unless "bailout" truly means bailout, not more debt.

Will Germany go along? The answer is almost certainly no. That means a Grexit or a default in June when this extension ends.

Can the Euro Be Saved?

Pettis says "Europe must decide if this [debt forgiveness] is a cost worth paying (and I think it is)."

I do not believe it's that simple (and that is not by any means simple).

Here's a better way of looking at things: "Is the euro so fundamentally flawed, and tensions so high that the euro cannot possibly be saved at all?"

I believe the answer to that question is yes.  If it is yes, then discussion better begin soon on how to exit from this mess.

If the answer is no, then someone needs to explains what it will take to get Germany to forgive enough debt to allow Speece to grow without perpetually high unemployment rates.

There are only three possible paths at this point.

Three Alternative Paths

  1. Enough debt writeoffs to allow Europe to grow
  2. High unemployment and slow growth in Speece, with stagnation elsewhere in Europe
  3. Breakup of the eurozone

There are no other realistic choices. Interestingly, none of them fixes the fundamental problem of "no enforcement mechanism" anywhere in the world.

 Let's turn now to the source of that particular problem.

Nixon Closed the Gold Window

The last semblance of enforcement mechanisms vanished when Nixon "temporarily" closed the gold window in 1971, refusing to let foreign central banks redeem their dollars for gold.

What else happened at the same time?

If you guessed debt soared as did income inequality, you guessed correctly.

Income Inequality

The above chart from The Rise and Fall of US Income Inequality (annotations in purple added with a hat tip to zero hedge for the idea).

Gross Federal Debt

Beggar Thy Neighbor

Nothing is in place anywhere to stop "beggar thy neighbor", competitive currency debasement, competitive QE, negative interest rates, and all sorts of other amazing distortions brought about by central bank policies in general, not just in Europe.

History suggests nothing will happen until there's a crisis.

We did not use the last crisis well. Global debt went up $57 trillion dollars or so since 2007 (see Seven Years Later, Global Debt Keeps Piling Up, $57 Trillion More Than 2007)

There was no deleveraging anywhere. And the leveraging up was certainly not for the benefit of the 99%.

Consumer Price Deflation vs. Asset Deflation

In their inane attempt to prevent consumer price deflation, the world's central banks have spawned massive asset bubbles in equities, junk bonds, and housing.

When those bubbles burst, they will spawn the extremely destructive asset deflation that central bankers ought to fear, but never do because central bankers never see the bubbles they create until they burst wide open.

Currency Crisis Awaits 

Global imbalances are so extreme, interest rate policy so absurd, and unsound fear of consumer price deflation that a massive currency crisis is all but inevitable now.

The currency crisis could start in Europe. But it could also start in Japan, the UK or anywhere.

Meanwhile, as long as there is no enforcement mechanism on spending and on trade imbalances, the bubbles will grow and grow and grow until central banks can no longer stuff anymore debt into the system.

Good luck when the bubbles pop. Let's hope the next crisis is handled better than the last one.

Don't count on it, especially when ...

  1. Central banks do not see themselves as part of the problem
  2. The 1% want to keep the status quo
  3. The Keynesians believe more spending is the answer to too much debt
  4. The Monetarists believe more printing is the proper response to too much printing
  5. The academics blame the 1% instead of the Fed (central banks).

Mike "Mish" Shedlock

Steen Jakobsen Warns „Euro is Not a Good Idea and ECB About to Make Biggest Mistake in History“

Saxo Bank CIO and chief economist Steen Jakobsen warns the US is not Europe, the Euro is not a good idea, and the ECB is About to Make Biggest Mistake in History.

Via Mish-modified translation from El Economista.
Steen Jakobsen has never been less outspoken regarding historic moment that is about to live the Eurozone. He explains his particular vision of the economy, bluntly. This morning, visiting Madrid, Jakobsen warned that quantitative easing (QE), printing money to buy government bonds, will be the biggest mistake of the European Central Bank, making matters worse.

In his view, the ECB wants to get funding rates low for listed and public companies. However, big companies have taken much of the credit, while SMEs (small and medium size enterprises) remain unfunded. Funding goes to the 20% of companies that "never again will create jobs." Interest rates declining few tenths more will not improve the economy.

Europe is not USA

Jakobsen says success stories like the three QE Federal Reserve (Fed) cannot be extrapolated to the Eurozone. His reason? The US is a net debtor and falling interest rates affects international creditors and rising national income. In Europe the opposite is true. Citizens of the euro countries are net savers, which means that falling interest rates deteriorates their income and does nothing to activate the economy.

In addition, Jakobsen believes that monetary stimulus suffers from a glitch: "The negative deposit facility and buying sovereign bonds are counter each other." This means that banks will not be willing to get rid of their bond portfolio to deposit excess liquidity at the ECB when interbank rates are negative.

In the case of monetary policy in the US, Jakobsen believes the Fed will have a very difficult raising interest rates in 2015. In his view, unless wages start to increase steadily, neither the Fed nor other major central bank may tighten monetary policy.

Consequences of Poor Construction of the Euro

To Jakobsen, many of the current problems stem from poor construction of the euro. "I do not think that the euro is a good idea. It's poorly built, without a fiscal union, and without consolidation of common funding streams for all member states. As designed, the euro does not have sufficient foundation to support the Eurozone.

ECB Has Done Nearly Everything Wrong

So the ECB has done it all wrong? No ... but almost.

The great mistake of the European entity was to allow the economic cycle of the economy take its course. "They have not allowed the market to purge mistakes and now the situation is worse.

Had the business cycle been left alone, many broken banks would have been acquired by larger ones, reducing debt and generating a prone position to lay the foundations for recovery indicates. Instead, entities transferred bad debts from one place to another, from financial institutions to "bad banks", not solving anything in the process.
"Full-Board Bingo"

That's a "full-board" European bingo, with every square covered.

The euro cannot and will not work because it's fatally flawed as I have noted for years.

Fatal flaws include no fiscal union, wildly differing social agendas of member states, wide variances in productivity, wage discrepancies, and retirement benefit discrepancies.

Those problems make it impossible to conduct monetary policy. The "Target2" system of payments is icing on the fatally flawed cake. (See Eurozone Target2 Imbalances Rise Again, Led by Italy).

Finally, I maintain QE did not work in the US either, unless "work" means creating one of the biggest equity bubbles in history coupled with the absolute biggest junk bond bubble in history.

Nothing Fixed Anywhere

It's not just Europe. Nothing has been fixed anywhere.

Bernanke says letting Lehman fail was his biggest mistake. What a bunch of nonsense. Lehman failed in every sense of the word.

In effect, Bernanke wanted to bail out a failed institution at taxpayer risk and expense. The markets need to purge excesses. Instead, central banks refuse to allow just that, blowing bubbles of increasing amplitude over time in the wake.

Mike "Mish" Shedlock

On Education

I much enjoyed this article by Steven Pinker.  An excerpt:

It seems to me that educated people should know something about the 13-billion-year prehistory of our species and the basic laws governing the physical and living world, including our bodies and brains. They should grasp the timeline of human history from the dawn of agriculture to the present. They should be exposed to the diversity of human cultures, and the major systems of belief and value with which they have made sense of their lives. They should know about the formative events in human history, including the blunders we can hope not to repeat. They should understand the principles behind democratic governance and the rule of law. They should know how to appreciate works of fiction and art as sources of aesthetic pleasure and as impetuses to reflect on the human condition.

On top of this knowledge, a liberal education should make certain habits of rationality second nature. Educated people should be able to express complex ideas in clear writing and speech. They should appreciate that objective knowledge is a precious commodity, and know how to distinguish vetted fact from superstition, rumor, and unexamined conventional wisdom. They should know how to reason logically and statistically, avoiding the fallacies and biases to which the untutored human mind is vulnerable. They should think causally rather than magically, and know what it takes to distinguish causation from correlation and coincidence. They should be acutely aware of human fallibility, most notably their own, and appreciate that people who disagree with them are not stupid or evil. Accordingly, they should appreciate the value of trying to change minds by persuasion rather than intimidation or demagoguery.

I believe (and believe I can persuade you) that the more deeply a society cultivates this knowledge and mindset, the more it will flourish. The conviction that they are teachable gets me out of bed in the morning.

Clash of Generations – Boomers vs. Millennials: Attitude Change Will Disrupt Wall Street and Corporate America

As boomers and gen-Xers hand over the economic reins to millennials, a once in a multi-generational attitude shift comes with it.

Unlike boomers and gen-Xers focused whose primary focus was on money and "getting ahead" lifestyles, millennials have more of a depression-era survival mentality coupled with a completely different set of values.

The ensuing attitude change has profound implications, and that is the focus of the Brookings study:  How Millennials Could Upend Wall Street and Corporate America.

Let's start with a couple of demographic definitions then a look at the study.

  • Boomers: Born 1946-1964
  • Generation X: Born 1965-1981 
  • Millennials: Born 1982-2003

Brookings Study Excerpts
Millennial Dominance

Millennial Values

By 2020, Millennials will comprise more than one of three adult Americans. It is estimated that by 2025 they will make up as much as 75 percent of the workforce. Given their numbers, they will dominate the nation’s workplaces and permeate its corporate culture. Thus, understanding the generation’s values offers a window into the future of corporate America.

In the future, most Americans, taking their cue from Millennials, will demonstrate a greater desire to advance the welfare of the group and be less concerned with individual success. They will be less worried about being guided in their daily decisions by software and more intrigued by the opportunities it offers. Even without any major environmental disaster, they will display a greater reverence for the environment and less interest in the acquisition of things as opposed to experiences.

It will be a world that is radically different than the one those who wield power today have grown accustomed to leading. The Baby Boom generation, born between 1946 and 1964, has made confrontation the touchstone of its existence. In their youth, Boomers protested the Vietnam War, or fought against those who did. As they aged, both conservative and liberal Boomers polarized America’s politics, making compromise morally unacceptable. Throughout their lives, Boomers have honed conflict and competition to a fine art.

As Boomers begin to leave the corridors of power in Congress and the executive suites of corporate America, they are being replaced by members of Generation X, who are largely devoted to the pursuit of the bottom line—preferring speed over reflection and autonomy over collective decision-making.

Silicon Valley CEOs, many of whom are drawn from the ranks of Generation X, look with disdain on the good old boys network of their Wall Street counterparts and are eager to leverage the technologies they have developed to gain advantage in the marketplace over the older, more established titans of the media and telecommunication sectors.

This is not to suggest that Millennial CEOs are, or will be, any less interested than Boomers or Gen-X’ers in assuring the success of the enterprises they now, or eventually will, lead. Rather, it is to emphasize the importance of recognizing the differences in how Millennials define success and the way they make decisions in order to envision the future of corporate America.  

Millennials as Consumer-Workers

Cone Communications has been tracking the attitudes of American consumers toward businesses’ involvement in social issues. As Millennials became a larger and larger share of the marketplace, the idea of “cause marketing” has evolved from a nascent promotional strategy to the key differentiator, not only in deciding what to buy, but who to trust and reward with brand loyalty.

Cone’s 2013 survey of over 1,200 U.S. adults found Millennials to be the generation most focused on corporate social responsibility when making purchasing decisions.

Almost all Millennials responded with increased trust (91%) and loyalty (89%), as well as a stronger likelihood to buy from those companies that supported solutions to specific social issues (89%). A majority of Millennials reported buying a product that had a social benefit and 84% of a generation that accounts for more than $1 trillion in U.S. consumer spending considered a company’s involvement in social causes in deciding what to buy or where to shop. In 2013, 89% of all American consumers said they would consider switching brands to one associated with a good cause if price and quality were equal. That percentage was 23 points higher than when Cone first did its survey in 1993, at a time when no Millennials were part of the adult population.

Not only are Millennials creating the need for companies to pay attention to their corporate social responsibilities, but they are also leading a shift in buying behavior away from the glorification of consumerism to a more measured view of what’s important in life. Young & Rubicam’s brand attribute survey in 2009 of 2,300 adults found that a majority of Millennials belonged to a segment labeled “Spend Shifters.” Not only did three-fourths of the “Spend Shifters” say they “made it a point to buy brands from companies whose values are similar to my own,” almost all of them (87.5%) disagreed with the statement that “money is the best measure of success.”

The authors of Spend Shift, John Gerzema and Michael D’Antonio, pointed to a major shift between 2005 and 2009, just as the first wave of Millennials became adults, in what consumers were looking for in the companies with which they wanted to do business. Attributes such as exclusive (-60%), arrogant (-41%), and sensuous (-30%) fell from favor while values more associated with those of the Millennial generation rose dramatically.

Kindness and empathy rose 391 percent in these five years, the biggest shift in attitudes ever seen in the seventeen year history of the survey. Other values associated with the generation, such as friendly (+148%) and socially responsible (+63%), also rose dramatically. These shifts in consumer attitudes driven by Millennial values will give every American corporation that wants to attract customers, not to mention workers and investors, no choice but to deliver on a commitment to make the world a better place one cause at a time. Companies will also have to behave a lot more nicely than they are accustomed to in order to deliver those results, more like the characters in “Her” than those in “The Graduate.”

Evidence that these attitudes represent a generational shift, not one based simply on age, can be found in a benchmark survey of 1,250 insurance company employees conducted for LifeCourse Associates in 2012. Almost two-thirds of Millennial employees said they wanted their employer to contribute to social or ethical causes they felt were important. Only half of the Boomers and older Gen Xers surveyed felt the same way.

This desire on the part of Millennials for their daily work to reflect and be a part of their societal concerns will make it impossible for corporate chieftains to motivate Millennial employees simply by extolling profits, or return on investment for their shareholders, or even employee salaries. For example, a recent Intelligence Group study found that almost two-thirds (64%) of Millennials said they would rather make $40,000 a year at a job they love than $100,000 a year at a job they think is boring. 

Millennials Think About Money Differently

In its latest study of the Millennial Generation, Millennials in Adulthood, the Pew Research Center found that America’s youngest adults were the least trusting of any generation.

Only 19 percent of Millennials agreed with the statement that “most people can be trusted,” a percentage that was about half of all other older generations.

A recent survey by MFS Investment Management found that nearly half of Millennials “never feel comfortable investing in the stock market.”  The survey also showed Millennials keep more of their assets in cash, less in stocks, and, in spite of their relative youth, have a shorter time horizon—less than five years—for their investments than Boomers or Gen Xers.

A report by UBS Wealth Management in the Americas described Millennials as “the most conservative generation since the Great Depression” with regard to its savings habits. According to UBS’s research, the average investor aged 21 to 36 has 52 percent of their savings in cash, compared to 23 percent for other age groups.

Clearly, one reason for this avoidance of the stock market stems from the same experience of extreme volatility and risk that the Millennials’ GI Generation great grandparents experienced when they were coming of age during the Great Depression. A 2013 study by Accenture confirmed these attitudes, with 43 percent of Millennials identifying themselves as conservative investors, compared with 27 percent for Generation X and 31 percent for Boomers. But the survey also uncovered a deeper reason than just the Great Recession for this cautious investing behavior by Millennials.

The Accenture survey found high levels of mistrust of financial institutions among Millennials and a greater reliance on the Internet, social media, and personal networks for financial advice. As Kelsey Raycroft, a Boston-based Millennial put it, “The personal connection is important to me, especially with money stuff.... When I see these commercials with big companies, I’d rather go to somebody I trust.”

In fact, this deep level of distrust toward the banking industry led the authors of the Millennial Disruption Index to identify the financial sector as the industry most likely to experience severe disruption in its business model. Their three-year research study of more than 10,000 Millennials also found that of the ten least-liked brands among members of this generation four belonged to the nation’s most powerful banks—J.P. Morgan Chase & Co., Bank of America Corp., Wells Fargo & Co., and Citigroup. Seventy-one percent told the researchers that they would “rather go to the dentist than listen to what banks are saying.”
Report Merits a Closer Look

There is much more in the 19-page PDF that merits a closer look.

For example, the study contains a discussion of what working 9-to-5 means at a place like Goldman Sachs. The short synopsis is that for the first couple of years, 9-to-5 means 9AM to 5AM, seven days a week.

In the list of companies where millennials would like to work, there are some non-surprises like Google and Apple, but also some real surprises like the FBI and CIA.  St. Jude's Children's Hospital, also a surprise, was the number one choice.

Major Attitude Shift

I have been writing about the implications of changing attitudes since at least 2008.

Flashback June 25, 2008: This is what I said about attitude changes in Peak Credit
Secular Attitude Change Underway

There is a secular attitude change happening right now. Boomers close to retirement are now (finally) scared to death as the equity in their houses has been vaporized. School age children are seeing homes foreclosed, and families destroyed over debt. The American consumer, who nearly everyone thinks will be back as soon as the economy picks up are mistaken.

Secular shifts like these come once in a lifetime. Sadly it's too late for many cash strapped boomers counting on equity in their houses for retirement.

Lessons Of The Great Depression Forgotten

The lessons of their great grandfathers who lived in the great depression era were forgotten. Over time, everyone learned to ignore the dangers of debt, risk, and leverage. Belief in the Fed and the government to bail out any problem are ingrained. Bank failures are distant memories.

Anyone and everyone who wanted credit got it, and on the easiest of terms: subprime, pay option arms, reckless leverage, and covenant lite debt and toggle bonds that allowed debt to be paid back with more debt. That's what it takes to hit a peak.

Peak Credit

Peak credit has been reached. That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.

It took nearly 80 years for people to get as reckless as they did in 1929. 80 years! Few are still alive that went through the great depression. No one listened to them. That is the nature of the game. The odds of a significant bout of inflation now are about the same as they were in 1929. Next to none.

Children whose parents are being destroyed by debt now, will keep those memories for a long time.
Social and Stock Market Impacts

Peak credit has been surpassed, but a substantial portion of the rise in credit is in the form of student loans that cannot and will not be paid back.

Importantly, millennial attitudes towards cars and other material goods is not the same as their parents. Moreover, student debt and a dearth of high-paying jobs ensures that housing formation will stay depressed, even if attitudes did not change.

As boomers retire, they will need to draw down on both their stock market portfolios and their savings (assuming they have either). Economic support from relatively low-paid millennials so that boomers can maintain their lifestyles will be massive.

Millennials will assist aging boomers via taxation and by overpaying for Obamacare. Higher taxes coupled with increasing time commitments to help care for aging parents will take a toll. And because boomers live longer than ever, the economic drain and time commitment from millennials will increase every year.

This has downward implications on the economy and the markets, especially in light of millennial-mistrust in stocks and the massive amount of student debt many of them carry.

Wall Street is not prepared for the major attitude and demographic shifts that are now underway. Are you?

In a related post, particularly for millennials searching for jobs, please consider BLS Employment Projections Through 2022: How Many Jobs Require a College Degree?

Mike "Mish" Shedlock
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