by Paul Collier
All the above policies are gradual. But it is feasible to achieve a quantum recovery in home ownership without jeopardizing house prices. This is by means of a stock transfer analogous to the discounted purchases of social housing that raised home ownership during the 1980s. Currently, the equivalent to the social housing of the 1980s is the policy-inflated stock of buy-to-let. Many such owners are sitting on huge and undeserved amounts of capital appreciation. The necessary public policy is a stock transfer from these landlords to their tenants, through legislating an entitlement to purchase, probably on similar terms to the deep discounts of the 1980s. To avoid inflicting financial distress on landlords, discounts could be bounded by any outstanding mortgage.* Evidently, this conflicts with the immediate self-interest of landlords. But re-assigning the rents of price appreciation on a home to those who live in it is both ethical and, given the benefits of enhanced belonging, consistent with the enlightened self-interest of the affluent.
Working to some purpose
Many of the educated people who are highly productive are hugely beneficial to society. But many are using their skills to enrich themselves at the expense of others.
The nexus of jobs in finance and law is the core of this diversion of talent. Return, for a moment, to the astounding volume of trading in financial assets. While active transactions can be useful to make assets liquid, much of the trading is zero-sum: were the volume of transactions reduced there would be no loss to society. If they are zero-sum, why do they happen? The answer is that the very smart outwit the slightly less smart. Asset markets are largely ‘tournaments’ in which the winners have some small informational advantage over the losers. The winners are those with the exceptional abilities and resources to outsmart others; as a result, they earn staggering amounts of money. Given the potential benefits of gaining an informational advantage, there is constant pressure to get access to information. A company invested in a high-speed cable between Chicago and New York that skims milliseconds off the transmission of price information between the two markets.20 The commercial return on the investment depended upon this generating a tiny advantage in computerized trading, so that it could be sold to a few companies that would exploit it at the expense of those that received the same information milliseconds later. A society in which investment in such a cable is undertaken while bridges are left to collapse due to lack of maintenance has not got its priorities right.
Excess asset transactions inflict several social costs beyond their damage to the horizon of firms, discussed in Chapter 4. One is that they widen inequality to no good purpose. The super-smart work for themselves: this is the implication of the bonus system in investment banks, where the stars in effect pay the firm a modest share of their individual profits for the services it provides. Deutsche Bank, the most extreme example of an investment bank run for stars, paid €71 billion in bonuses, dwarfing the €19 billion paid to shareholders.*
Power is no longer in the hands of owners of capital, nor even of the managers of their wealth. Pension funds cannot pay the mega-salaries that would be required to recruit stars, and so they are managed by the slightly less smart. Transactions between the two groups generate a gradual transfer from future pensioners to the super-smart.
A further loss is that these zero-sum tournaments tie up some of the smartest people in society doing work that is of no use to anyone else. Yet such people are potentially hugely valuable to others. At the opposite end of the spectrum from asset management is innovation. Economists estimate that typically an innovator captures only around 4 per cent of the overall gains from their innovation: the remaining 96 per cent accrues to the rest of us. So, the incentives that the market provides for the super-smart to deploy their scarce abilities on innovation are far too weak, while the incentives to use them for trading assets are far too strong. I have not seen any attempt to quantify this form of social cost, but my sense is that it is considerable: innovation and asset management are both huge sectors. In America, the profits generated by the financial sector are around 30 per cent of all corporate profits. Looked at another way, the financial sector is supposedly providing services that make the economy more productive, but it would need to be raising the profitability of the rest of the economy by 43 per cent* just to pay for the profits that it captures for itself, before the rest of us break even. This seems unlikely: would we really notice that much difference, were our financial sectors leaner?
What is true of asset managers is true of lawyers. Willem Buiter, former Chief Economist for Citigroup, puts it aptly: the first third of lawyers produce the immense social value we know as the ‘rule of law’. The next third are working on legal disputes that are essentially zero-sum games: each side over-invests in winning the tournament and so they are socially useless. The rule of law is a huge public good, but no commercial lawyers are working to achieve ‘justice’; they work to win a case in a tournament. The last hour of such legal effort purchased by a party to a legal dispute yields its return not by generating more justice, but by increasing the chances of winning the tournament at the expense of the other party. The final third of lawyers are socially predatory: they are employed in the legal scams that fleece the productive. They are the ultimate rent-seekers. In America, one of these scams, in which redundant patent rights were bought up and twisted into law suits that extorted money from firms that innovated, was so egregious that even a gridlocked Congress had the gumption to close the loophole. In Britain, when lawsuits that relied upon a medical insurance scam were outlawed, the market value of the law firm that specialized in it halved overnight.
Lawyers are valuable, but there are too many of them. Young people are attracted into the profession by a multitude of incentives. I recall that my initial choice of law as a degree course was because I naïvely imagined that lawyers were the modern equivalent of pastors, advising, adjudicating, helping, and sometimes they are just that. But I changed my choice once I found out that 70 per cent of the incomes of British lawyers came from their monopoly on housing transactions: the profession was dominated by rent-seeking. Far from being a pastor, I would be a parasite. Nowadays many young people are attracted by the idea of battling for justice – courtroom battles are a staple of Netflix. The seven-figure incomes of City lawyers may also have a certain appeal. But, like actors, there are too many of them. The eminent Harvard economist Larry Summers once produced a correlation between the ratio of engineers to lawyers in a society and the nation’s rate of growth: it was a neat metaphor for the larger issue that market forces do not deliver the right balance between those activities that are socially predatory and those, like innovation, that are socially valuable.
So, what can be done about it? As with the metropolis, part of the answer is tax, but there is an important difference. The rents generated by the metropolis are socially valuable; they are just unfairly shared. The purpose of taxing the highly skilled workers in the metropolis would not be to curtail their activities but to redistribute the rents. In contrast, the rents captured by asset traders and lawyers are not socially valuable; it is the activities themselves that need to be curbed. Hence, it is the purpose of the activities, rather than the location, that should be the target.
There have been many proposals for taxes on financial transactions. Any such taxes need to be carefully designed to hit the right transactions; for example, trading in the shares of companies needs curbing much more that trading in currencies. It is not remotely socially useful for the shares of the typical large company to change hands seven times in a single year, which is the current norm.
As for taxing private litigation in courts, it could be designed both to reduce the volume of disputes and to reduce the large rents on them that lawyers currently capture. Lawyers are not immune to the lure of self-interest. When contracts were paid by the word, lawyers deemed it necessary for them to be very long; once they were paid by the contract instead of the word, they rapidly became radically shorter. Legal costs escalate to eat up the rent
s involved in the dispute. To take a recent dispute that is familiar to many British people, consider what happened when the politician Andrew Mitchell sued a newspaper for defamation. The substance of the dispute was the precise words he had used in an altercation with a policeman who had stopped him from wheeling his bicycle through a gate. Since there were no decisive witnesses, the case was resolved by a judge determining which of two testimonies to trust: that of Mr Mitchell or that of the policeman. In the process of this trivial matter, the lawyers on each side ran up costs of £3 million, which became the liability of the losing party. In other words, this trivial legal task ate up the equivalent of the average lifetime earnings of three British households. By taxing such disputes, we can encourage more of them to be settled more simply, and also shift some of the rents from the inflated costs of lawyers to society. Lawyers will explain why such a proposal is an affront to justice.*
There is another approach: shame. Just as ethical citizens are needed to shame firms into more purposive behaviour, so the power of social sanction can strip the rent-seeking professions of their glitzy veneer. Talented young people need to be brought face-to-face with the social implications of their career choices: how are mega-incomes actually being generated?
Curbing social divergence
Until 1958 Buckingham Palace held an annual ball for debutantes, a forum for match-making among the top echelons of British society. It stopped when enough people recognized that perpetuating class divisions in this way was a menace, not a service. The greater porousness of the old upper class is symbolized by the marriage of Prince William to Kate Middleton, whose mother had been an airline stewardess: Kate would not have been invited to a debutante ball. But ‘assortative mating’ among the old upper class has been replaced by even more effective assortative mating among the new elite.21 Prince William and Kate met while studying at St Andrews, an elite university. Like-marrying-like is a powerful force for social inequality. Such assortative mating, a force that helps stabilize marriages, inadvertently widens class divisions, but there is little that can be done about it.
But some behaviour is exploitative, and could potentially be curbed. In America between 1981 and 1996 children at elementary school increased their hours of study by an astonishing 146 per cent.22 In Britain during the past decade, suicide rates among university students have risen 50 per cent. Because there are zero-sum aspects of the success on which ‘tiger parents’ fixate, their stress is transmitted not just to their own children but to others. To an extent, this could be tackled in schools. Heads and their staff naturally try to establish a prevailing culture. Mostly, their struggle is to place a lower limit on academic effort, but perhaps there also needs to be an upper limit. While we cannot afford to fall behind global standards, the teenage years should not be turned into a junior version of the toxic rivalries of an investment bank.
As to those toxic rivalries, a story that hit the headlines in 2013 was of a summer intern at an investment bank, so keen to impress that he worked a twenty-hour day before dropping dead. This is an extreme instance of a race to the bottom that drives groups of people to become workaholics. Everybody would gain from working less, but no individual dares to step out of line: they would lose out in the race for promotion, and by breaching prevailing norms they would lose esteem. This is a classic co-ordination problem and it has a straightforward solution – public policy. Long hours of work can be discouraged by taxation, or curtailed through regulation. When the French government reduced the permitted working week to thirty-five hours it was widely derided. But I recall a harassed manager in a workaholic organization wistfully noting that his own CEO was trying to impose a thirty-five-hour day. Gradual reductions in working hours, and corresponding extensions of vacations, are appropriate and necessary ways of turning rising national productivity into better lives. Without them and the policies proposed above, society will become further divided into a workaholic skilled class with abundant money but little time, confronting an underemployed, unskilled class with abundant time but little money.
CONCLUSION: SOCIAL MATERNALISM WITH A HARD EDGE
Work should bring purpose to the core years of life. Currently, it does so for many of the fortunate, but not for all. Many people find themselves in jobs that offer too little opportunity for self-respect: they contain insufficient skill for it to be a source of pride, or they lack the satisfaction that comes from knowing that what you do contributes to society. This, rather than simply the differences in pay packets, is the crux of the failures by which divergences between families become divergences between jobs. The income inequalities matter and get larger as life progresses through to retirement. But if they are only addressed by redistribution, not only will the required taxation-cum-benefits be enormous, the core deficiency of purpose, or meaning, will be accentuated. Many people will be living on the productivity of others.
The challenge is to reduce the widening dispersion of productivities. Addressing it has taken us through a long march that began with the switch from social paternalism, in which the state polices recalcitrant families, to social maternalism, in which the state cushions them with practical support. The hard edge that social paternalism projects on to those families falling apart is more appropriately wielded, I have suggested, against the damaging activities of a minority of the most successful. Both will be needed to build a capitalism that enables everyone to work with dignity, wherever they live.
9
The Global Divide: Winners, and the Left Behind*
Globalization has been a powerful engine for rising global living standards. The economics profession, divided on many issues of public policy, has been virtually united on this assessment. But the sustained advice of economists has lost the confidence of the public. In part, the profession had forfeited its ‘licence to operate’ as a result of the global economic crisis. But there is a more focused reason: our enthusiasm for globalization has been insufficiently nuanced. This is odd, because ‘globalization’ is not even an economic concept. It is a journalistic amalgam of radically different economic processes that are highly unlikely to have common effects, let alone be universally benign.
The profession has been unprofessional, fearful that any criticism would strengthen populism, so that little work has been done on the downsides of these different processes. Yet downsides were apparent to ordinary citizens, and the effect of economists appearing to dismiss them has resulted in a widespread refusal of people to listen to ‘experts’. For my profession to re-establish credibility we must provide a more balanced analysis, in which the downsides are acknowledged and properly evaluated with a view to designing policy responses that address them. The profession may be better served by mea culpa than by further indignant defences of globalization.
THE TRADE MEA CULPA
The mea culpa starts with trade, which causes powerful redistributions both within and between societies.
Within societies, the proposition of comparative advantage tells us that, because trade brings mutual gains, with appropriate compensation through redistribution within each society it would be possible to make everyone better off. As a profession, we have elided from that true proposition to the patently false one that everyone in a society is made better off. International economics has shown little interest in internal mechanisms of compensation. This is the more important because of two features ignored in simple models: losses are largely transmitted through the labour market, and they are geographically concentrated. When Sheffield lost its steel industry, the knowledge that somewhere else in Britain the consumption gains more than offset the consumption losses of Sheffield’s unemployed would not have been much solace.
Between societies, global trade has driven countries into different specializations. In a one-sentence summary, Europe, the USA and Japan have specialized in the knowledge industries; East Asia in manufacturing; South Asia in services; the Middle East in oil; and Africa in mining. This has enabled both East and South Asia to converge spec
tacularly on the high-income societies, reducing global inequalities as never before. But natural resource extraction places exceptional stresses on governance because it generates enormous economic rents whose ownership must be determined politically. Some societies manage these stresses, but many suffer from huge diversions into rent-seeking. For example, oil has not benefited South Sudan: it has triggered a conflict-induced famine and mass displacement. The global boom in commodity prices of 2000–2013 appeared at the time to be powering Africa and the Middle East forward, but this now looks doubtful. Remarkable new global data has collated comprehensive measures of national wealth per capita, including not only the conventional components such as the capital stock, but education and natural wealth as well.1 The data provides two snapshots – 1995 and 2014 – fortuitously spanning the commodity super-cycle. From it, we can see whether the unprecedented temporary increase in the natural resource earnings of many poor countries has led to gains that can be sustained. What it reveals is that the poorest countries fell further behind everyone else. Not just the absolute increase, but the percentage increase in per capita wealth was much less in the low-income countries than in all other income groups, and in much of Africa wealth actually fell. As with the effects of trade within societies, the cheery models show only potential. Moving from potential to realization depends upon public policies that the models finesse.
