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.

  1. LavrentiBeria says

    Wanted to raise this question yesterday but didn’t. You pointed then to “crony capitalism” as your reason for being opposed to more stimuli and relegated that cause in the future to Auerbach. You offered no explanation of why “crony capitalism” obviates further stimuli. Is it that you have become convinced that the “system” as presently constituted is simply incapable of producing worthy stimuli to meet the jobs crisis, say CCC or WPA type programs. If so, your complaint goes far deeper than Auerbach’s who, despite his obvious discomfort with it, continues to hold forth for more spending, a position which implicitly holds out hope for it, of course. Is it that you’ve given up on the system’s capacity to do the right thing? If so, that would be easy enough to understand from the avaiable evidence.

    1. Edward Harrison says

      I’m a bit short on time so I may come back with more thoughts on this in comments or a future post but here is what I wrote in comments at the last year review on stimulus:

      My take: there is always a risk in having government ‘intervene’ in the economy. But, given the market failure last year, it was a risk worth taking. The alternative is collapse. And while collapse can lead to the relatively benign 1920-21 outcome most Libertarians point to in America, it can also lead to the much harsher experiences Germany and Italy suffered in the early 1920s.

      So if we were faced with the same post-Lehman choices again, I would advocate a strong and muscular government response again. I will actually write on this theme of crisis response later, but I had advocated a more free-market solution at the time. This was not the direction we went.

      As for stimulus, there again I would probably advocate the same, especially an increase in automatic stabilizers like unemployment insurance but I would of course have wanted the bankruptcy process to facilitate a liquidation of malinvestment in autos, in finance, in housing, etc.

      …if you read my three December 08 posts referenced in the stimulus piece, you will see that I don’t think fiscal stimulus is a “panacea.” After all, the government can’t make up for all the lost output of the public sector and more government spending is likely to increase malinvestment. there is only so much the government can or should be allowed to do. On this score, implicitly, I have far less faith in government than Marshall or Krugman.

      So, I would advocate stimulus if I had to do it again. But, you have to do so based on the facts as they stand and you are right in part when you say I “have become convinced that the “system” as presently constituted is simply incapable of producing worthy stimuli to meet the jobs crisis, say CCC or WPA type programs.”

      Don’t get me wrong, there is a limited role for jobs programs – even a WPA type one, but you have to be realistic about the chances that this will help lead to sustainable recovery.

  2. Advocatus Diaboli says

    Hey, I read your posts on

    What do you think about my ideas on money, and I am aware that they will not come to pass unless we have severe dislocations in our current setup.

    PS- I write other controversial stuff too, just saying.

    1. Edward Harrison says

      I haven’t read the link yet but the Darth Vader video is good for its irony. I had seen it before. Gotta post it soon! Cheers.

  3. TOm Lindmark says

    Interesting stuff. Do you plan to address your thoughts on a more optimal structure? I’m looking forward to the rest of the posts and your synthesis.

    1. Edward Harrison says

      Some great commentary at Naked Capitalism might have me putting some verbatim comments up as a post. Just got one from a Phd in neuroscientific psychology.

  4. Anonymous says

    I have noticed a misconception from the left multiple times since the crisis began: that free market advocates generally believe “free” means utterly unregulated. That notion is a straw man that undermines whatever else a writer might have to say. Free market advocates in general want markets that are as free as reasonably possible (for all the well known efficiency reasons) but understand and believe in the need for regulation around the edges (just as a basketball coach who wants a referee to “let ’em play” does not actually advocate no refereeing at all). I have NEVER read a free market advocate suggest zero regulation; I have ONLY heard left-leaning writers frame free markets as zero regulation so that they can scoff at the notion.

    As for a kleptocracy, I sense a blinding agenda there, a predicate that assigns primacy to one form of self interest over others that are in fact more evident. Rich, successful people are good at adding to their wealth by definition, but there are not enough of them to take over democratically elected government and direct public wealth to themselves. There are, however, enough of the poor to vote in whomever they wish; the artifical distribution of wealth is going downstream these days, not up. The mere existence of increased wealth at the top in recent years is not evidence of a scheme to extract it from the poor; it is an artifact of the shift from manual (common) to intellectual (rare) economic inputs over the last 50 years. So the only societies where a kleptocracy can thrive are non-democracies like Soviet Russia or African dictator states, etc. On the other hand, government does like to increase its own wealth and power, as we can see across the West today. A politocracy is much more likely before we get to a kleptocracy; if we keep ceding more of our freedom/wealth to government eventually a kleptocracy may develop as the rich and powerful go to Washington rather than New York or London.

    1. Edward Harrison says

      First of all, I am not on the left. I am one of those advocates of free markets who doesn’t generally believe markets are always free. If you read what I say here or anywhere else for that matter, you would actually understand that I am advocating for freer markets.

      But there ARE those who believe in NO regulation – Greenspan being a perfect example, believing fraud was self-regulating.

      As for schemes, there are no conspiracy theories my friend, just self-interest and the inexorable pull in one direction or another that this self-interest creates.

      I find your arguments about government facile. Government is not completely divorced from the populace. Those in government are self-interested as well but they do not work in a vacuum. They need votes and that means serving their self-interest necessarily means pandering to one group or another.

  5. Anonymous says

    outstanding! You are an important thinker. I will paying more attention to you from now on.

Comments are closed.

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