The year in review at Credit Writedowns – Kleptocracy

Yesterday, I indicated I would write a few thematic posts as a look back at some of the more important economic topics that this credit crisis has uncovered. Tying posts together in a theme definitely gives a better holistic view of a the themes than the posts do in isolation. But I also enjoy writing this because the review process gives me a better perspective of where we have come from and helps judge where we are headed.

Yesterday, I wrote about economic stimulus. My conclusion was that while stimulus may have helped avert crisis, the process made clear that crony capitalism is alive and well. So, the second topic I wanted to address today was crony capitalism. However, in writing this post, the lead in describing kleptocracy became so long that I decided to cut this into two bits; this first one is on kleptocracy and a later one will be on crony capitalism.

The first post I wrote related to kleptocracy was in March of 2008 called “A populist interpretation of the latest Boom-Bust cycle.” At the time, I wasn’t really blogging very seriously. I had just started two weeks earlier and wanted to flesh out some ideas that I had long considered germane to the understanding of the credit crisis. But, in retrospect, the thesis I developed in this post has become central to my thinking about how the American and global economy have evolved in the fiat currency era.

Kleptocracy defined as the status quo

The thesis was this:

[Jared] Diamond postulates that more stratified societies are by definition less egalitarian, but more efficient and are, thus, able to eradicate or conquer more egalitarian, less stratified societies. Thus, all ‘advanced’ societies with high levels of GDP are complex and hierarchical.

The problem is: these more stratified, more complex societies are in essence Kleptocracies, where those in power re-distribute societal wealth to themselves. Those at the bottom of the society’s pyramid accept this unequal, non-egalitarian state of affairs because they too benefit from their society’s relative advancement. It’s a case of a rising tide lifting all boats.

In short, the playing field in all modern day nation states is by definition unequal. The question is whether this should be tolerated, mitigated or eliminated. An unwritten assumption I made when I wrote the post is that humans are genetically programmed for fairness. My understanding is that scientific studies have convincingly demonstrated that human beings will actually consciously disadvantage themselves to seek revenge as a means of restoring justice and fairness.

This would suggest that a major flaw in neoclassical economic models, especially as regards a self-equilibrating economy, is the focus on rational expectations and efficiency at the expense or fairness and/or irrationality. A neoclassical economist might tell you that a rising tide lifts all boats and it is rational self-protection for economic agents (aka real human beings) to accept inequality for this very reason. But, in the real world, fairness and justice are important as well. And when an economic system is deemed unfair, people will go so far as to hurt themselves economically in order to level the playing field.

Stability of status quo leads to overreach and instability

So, my thinking is this: because of the natural state of inequality endogenous to any stratified society, over time the natural tendency of any ruling elite is to deploy the state’s coercive power for greater and greater self-benefit. I liken this to Hyman Minsky’s instability of economic stability theorem. The stability of power leads to overreach and overthrow. This is a view largely consistent with Paul Kennedy’s themes of imperial overstretch in his book The Rise and Fall of the Great Powers.

In the post I expressed these sentiments saying:

Diamond says the Kleptocrats maintain power using 4 different methods:

“1. Disarm the populace, and arm the elite.”

“2. Make the masses happy by redistributing much of the tribute received, in popular ways.”

“3. Use the monopoly of force to promote happiness, by maintaining public order and curbing violence. This is potentially a big and underappreciated advantage of centralized societies over noncentralized ones.”

“4. The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy.”

Kleptocracy in America?

The obvious corollary of this theory is that most successful modern societies are, in fact, kleptocracies. The key is to use the four methods to gain popular support in order to re-distribute as much wealth to the ruling class as the populace will support. If the ruling class takes too much, it will be overthrown and replaced by a new ruling class (which in turn will re-distribute wealth to itself using the same four methods).

How the status quo maintains the status quo

Let me take these points one by one. I will preface this by saying that, as the stability of the economic status quo disintegrates into instability via economic depression, you should expect the ruling elite to step up uses of these methods of retaining power.  So when I wrote in my Depression piece about “more muscular forms of government,” this is part of what I was referring to.

As Libertarians see it, the right to bear arms is an essential in stopping the elite from maintaining power unjustifiably. Obviously, which arms, when they can be borne and how is a constitutional issue that goes to the heart of American democracy.

The second issue is about “bread and circuses” or what I call the anesthetizing of the populace as ironically demonstrated in this Star Trek “Bread and Circuses” from TV, our own modern-day agent of mental anesthesia.

The third issue is about totalitarianism.  Civil libertarians like myself see the permanent war state as promulgated by the Bush administration post 9/11 – and now maintained by the Obama Administration – as a clear sign that the state’s use of the monopoly of force to promote order is rising and will continue to do so. Eisenhower’s military industrial state warnings were warranted. You can see some of the articles on that very topic here in my bookmarks. And you should note Obama’s poor record on civil liberties.

The last (and perhaps most important) issue, in my view, has to do with the unabiding faith in free markets that many now have. It is with religious zeal that these so-called Libertarians defend the primacy of markets over all else when in reality common sense would tell you that those with the greatest influence and money will always be at an advantage without some check on that influence and power.

How ideology is central to retaining the status quo ante

I think this last point is important. Think of how Diamond phrased this:

The remaining way for kleptocrats to gain public support is to construct an ideology or religion justifying kleptocracy.

The important thing to realize here is that ideology is a tool used to control the masses while those in power re-distribute to themselves. Diamond was probably talking here about ancient societies: the Mayans, Incas, the Greeks, the Romans, Easter Island. But, it does apply quite well to the modern-day. After all, in the U.S. average hourly earnings peaked more than 35 years ago. And we can see that most of the economic gains of the last two decades has been an illusion masked by gobs of debt.

But freshwater economists have this view that the economy is always self-equilibrating and this means government must be held at bay any- and everywhere lest it reduce the efficiency of the free market. This is an extreme ideological position which gained sway in the aftermath of the disaster of the 1970s. Fed Chairman Alan Greenspan was an adherent of this ideology despite holding a central planning position as Federal Reserve Chairman which was antithetical to the views he espoused.

Markets are wonderful. A largely market-based economy is certainly more ‘efficient’ than a non-market based one (ask the Soviets). But, markets are not self-regulating. They fail – and catastrophically so. But no manner of real world experience seems to shake ideologues’ free-market zeal. To give you an example of the mindset, Alan Greenspan is reported to have thought that markets could even self-regulate fraud – no regulatory oversight necessary. 

See the video in Frontline – The Warning: Who Knew About the Looming Financial Crisis for this particular revelation and Ms. Watkins, why does Charlie have lit dynamite? for why this is absurd. Even when you think Greenspan has learned something, he proves time and again that he just doesn’t get it. And don’t think he is alone in officialdom. Former Fed official Frederic Mishkin has shown he doesn’t get it either.

Not only is the freshwater view of rational economic agents and efficiency completely ignorant of the role of fairness, it also disregards the very real tendency for power to consolidate over time and to lead to crony capitalism. This is what I refer to as “deregulation as crony capitalism.” I see it as central to the causes of the crisis.

I will pick up on this theme in a later post. Next up on my year in review is a post on crony capitalism in action and how the credit crisis solutions reveal that the ruling elite want to return to the status quo ante. Overreach has been the order of the day and will ultimately invite an opposing response.