Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else

by Chrystia Freeland

  Roger Martin, a management consultant and business school dean, thinks that over the past three decades another force has come into play: superstars aren’t just earning more from their clients, they are increasingly able to extract a greater amount of the value of their work from their employers. In Martin’s view, this dynamic, which he describes as the struggle between talent and capital, is tilted in favor of the “talent,” or the superstars. Just as the fight between labor and capital defined the first stage of industrial capitalism in the nineteenth and twentieth centuries, Martin argues that the battle between capital and talent is the central tension in the knowledge-based postindustrial capitalism of the twenty-first century.

  Here is how Martin laid out his theory in the Harvard Business Review: “For much of the twentieth century, labor and capital fought violently for control of the industrialized economy and, in many countries, control of the government and society as well. Now . . . a fresh conflict has erupted. Capital and talent are falling out, this time over the profits from the knowledge economy. While business won a resounding victory over the trade unions in the previous century, it may not be as easy for shareholders to stop the knowledge worker–led revolution in business.”

  Martin’s thesis helps explain one of the most striking contrasts between today’s super-elite and their Gilded Age equivalents: the rise, today, of the “working rich.” As Emmanuel Saez found, the wealthiest Americans these days are getting most of their income from work—almost two-thirds—compared to a fraction of that, roughly one-fifth, a century ago.

  Martin’s theory about the growing power of “the talent” builds on the ideas of Peter Drucker, the Austrian-born scholar who laid the intellectual foundations for the academic study of management. That means you can probably blame Drucker for far too many soul-destroying PowerPoint presentations, peppy but hollow business books, and inspirational corporate “coaches” with lots of energy but no message. But Drucker also, more than half a century ago, predicted the shift to what he dubbed a “knowledge economy” and, with it, the rise of the “knowledge worker.”

  Drucker made his name in America, but he was a product of the Viennese intellectual tradition—Joseph Schumpeter was a family friend and frequent guest during his boyhood—of looking for the big, underlying social and economic forces and trying to spot the moments when they changed. Accordingly, he saw the emerging knowledge worker as both the product and beneficiary of a profound shift in how capitalism operated. “In the knowledge society the employees—that is, knowledge workers—own the tools of production,” Drucker wrote in a 1994 essay in the Atlantic. That, he argued, was a huge shift and one that would, for the first time since the industrial revolution, shift the balance of economic power toward workers—or, rather, toward one very smart, highly educated group of them—and away from capital.

  As Drucker explained: “Marx’s great insight was that the factory worker does not and cannot own the tools of production, and therefore is ‘alienated.’ There was no way, Marx pointed out, for the worker to own the steam engine and to be able to take it with him when moving from one job to another. The capitalist had to own the steam engine and control it.” Hence the power of the robber barons and the complaints of the proletariat.

  But that logic collapses in the knowledge economy: “Increasingly, the true investment in the knowledge society is not in machines and tools but in the knowledge of the knowledge worker. . . . The market researcher needs a computer. But increasingly this is the researcher’s own personal computer, and it goes along where he or she goes. . . . In the knowledge society the most probable assumption for organizations . . . is that they need knowledge workers far more than knowledge workers need them.”

  Here, then, is another way that some of the highly talented are catapulted into the super-elite: when it becomes possible for them to practice their profession independently. Or, to put it another way, when the tool of their trade is a personal computer, rather than a steam engine.

  Of course, even during the first machine-driven thrust of the industrial revolution, there were some superstars who remained beyond the thrall of the capitalists. A painter needed only oil and canvas; a lawyer needed only his education, wits, and admission to the bar. It is no accident that it was the superstars of these two professions that Marshall, writing in 1890, singled out as benefiting disproportionately from the Western world’s economic transformation.

  In the knowledge economy, more and more professions use a laptop rather than a steam engine, and that means that the superstars in these fields are earning ever greater rewards. The intellectuals are on the road to class power.

  THE STREET AND THE SUPERSTARS

  The biggest winners are the bankers. They did well enough, to be sure, in the industrial revolution. They were among that era’s plutocrats—think J. P. Morgan in New York, or Siegmund Warburg in the City of London. But these were the owners of capital. Their employees, the salaried financial professionals, weren’t nearly as richly rewarded. Their job was just to keep score.

  In the postwar era, with the steady rise of the knowledge economy, the bankers’ role has been dramatically transformed. Instead of working for the owners of capital—whether they are industrial magnates or the shareholders of publicly traded companies—financiers have discovered they can themselves own the capital and, with it, the companies. Critically, this shift from wage earner to owner has been accomplished not just by one or two stars at the very top of the field—the Oprah Winfreys or the Lady Gagas—but by thousands. In 2012, of the 1,226 people on the Forbes billionaires list, 77 were financiers and 143 were investors. Of the forty thousand Americans with investable assets of more than $30 million, a group described by Merrill Lynch, which produces the premier annual study of the wealthy, as “ultra high net worth individuals,” 40 percent were in finance. Of the 0.1 percent of Americans at the top of the income distribution in 2004, 18 percent were financiers. Bankers are even more dominant at the very tip of the income pyramid. In a study of the 0.01 percent, Steven Kaplan and Joshua Rauh found Wall Street significantly outearned Main Street. Collectively, the executives at publicly traded Wall Street firms earned more than the executives of nonfinancial companies. Wall Street investors, such as hedge fund managers or private equity chiefs, did even better. “In 2004,” Kaplan and Rauh write, “nine times as many Wall Street investors earned in excess of $100 million as public company CEOs. In fact, the top twenty-five hedge fund managers combined appeared to have earned more than all five hundred S&P 500 CEOs combined.”

  You can trace this transformation of bankers from accountants and clerks to the dominant tribe in the plutocracy to three new forms of finance pioneered in the decade after the Second World War, and to three very different men who lived within five hundred miles of one another on the East Coast stretch running from Boston to Baltimore.

  The first was Alfred Winslow Jones, a patrician New Yorker (his father ran GE in Australia), who invented the modern hedge fund in 1949 when, as a forty-eight-year-old journalist with two children and two homes, he decided he needed to make more money. The second was Georges Doriot, a French-born Harvard Business School professor who invented the modern venture capital business in 1946 as a way to encourage private investment in start-ups founded by returning GIs. The third was Victor Posner, the teenage school dropout son of a Baltimore grocer who pioneered the hostile takeover business (now usually known by the more genteel name of “private equity”) in the 1950s.

  Together, this trio spearheaded the transformation of finance from an industry dominated by large institutions whose job was the conservative stewardship of other people’s money into a sector whose moguls were iconoclastic entrepreneurs who specialized in risk, leverage, and outsize returns. The broader economic impact of this revolution remains debatable—you could argue that these three men are the fathers of the instability of modern financial capitalism—but it was clearly crucial in the rise of the super-elite. Hedge funds, venture capital, and private equ
ity transformed finance—previously the dependable plumbing of the capitalist economy—into an innovative frontier where smart and lucky individuals could earn nearly instant fortunes.

  The biggest beneficiaries are those who strike out on their own. And the would-be masters of the universe know that. David Rubenstein, the billionaire cofounder of the Carlyle Group, one of the world’s biggest private equity firms, told me that when he visited America’s top business schools during their spring recruiting season in 2011, he discovered that everyone wants to be an entrepreneur. “When I graduated from college, you wanted to work for IBM or GE,” he told me.” Now when I talk to people graduating from business school, they want to start their own company. Everyone wants to be Mark Zuckerberg; no one wants to be a corporate CEO. They want to be entrepreneurs and make their own great wealth.” That quest starts earlier and earlier. Jones and Doriot were both nearly fifty when they started their businesses. Nowadays, would-be plutocrats want to be well on their way to their fortune by their thirtieth birthday.

  THE BILLIONAIRE’S CIRCLE

  But the real mass revolution sparked by the rise of entrepreneurial finance is in the way that it reshaped the big institutions it threatened to usurp. Civilians—which is to say anyone who doesn’t work on Wall Street (or maybe in Silicon Valley)—tend to think of the $68 million earned by Lloyd Blankfein in 2007, just before the crash, or the $100 million bonus earned by Andrew Hall, Citigroup’s star energy trader, in 2008—as princely fortunes. On the Street itself, though, even the most successful and lavishly compensated employees of the publicly listed firms see themselves as also-rans compared to the principals of hedge funds, venture capital firms, and private equity companies.

  We got a glimpse of that way of thinking when federal agents were allowed to tap the telephones of Raj Rajaratnam, a billionaire hedge fund founder, and his network of contacts. In one of those conversations, Rajaratnam and Anil Kumar discuss their mutual friend Rajat Gupta, the Indian-born former head of McKinsey, a company that epitomizes the rise of the managerial aristocracy. Gupta was on the board of Goldman Sachs, one of the most prestigious in the world. But he had been invited to the board of KKR, one of the four biggest private equity firms. Serving on both would be a “perceived conflict of interest,” because KKR and Goldman often compete for the same business. That left Gupta with a tough decision, but he was leaning toward KKR. Here, according to Rajaratnam, is why: “My analysis of the situation is he’s enamored with Kravis [one of the three founders of KKR] and I think he wants to be in that circle. That’s a billionaire’s circle, right? Goldman is like the hundreds of millionaires’ circle, right? And I think here he sees the opportunity to make $100 million over the next five or ten years without doing a lot of work.”

  That phrase—the billionaire’s circle—is the key to how the entrepreneurs of finance transformed the wider culture of Wall Street, and thus of the global banking business. Thanks to Jones, Doriot, and Posner, being in the “hundreds of millions” circle isn’t enough. To understand how that sentiment has ratcheted up individual compensation for Wall Street’s salarymen—not just the entrepreneurs who take the risk of going it alone—consider this fact: in 2011, 42 percent of Goldman Sachs’s revenues were spent paying its employees, who earned an average of $367,057. Nor is that princely compensation restricted to the über-bankers at Goldman Sachs. At Morgan Stanley, which made a $4 billion mistake on the eve of the financial crisis and whose recovery from it has been lackluster, compensation accounted for 51 percent of revenue in 2010. At Barclays, which now owns Lehman, the figure was 34 percent; at Credit Suisse, it was 44 percent. To put it another way, on Wall Street, in the battle between talent and capital, it is the talent that is winning. Wall Street is the mother church of capitalism. But its flagship firms are run like Yugoslav workers’ collectives.

  THE MATTHEW EFFECT

  Matthew of Capernaum was a Galilean tax collector and the son of a tax collector. He became one of Jesus Christ’s apostles, the patron saint of bankers—and one of the first thinkers about superstars. What he noticed was the ratchet effect of superstardom: “For unto every one that hath shall be given, and he shall have abundance; but from him that hath not shall be taken away even that which he hath.”

  The Marshall effect, the Rosen effect, and the Martin effect are all about the ways in which superstars are able to be better paid for the value they create—thanks to richer clients (Marshall), more clients (Rosen), and better terms of trade with their financial backers (Martin). The multiplier effect that Saint Matthew observed is what makes all these drivers of superstardom so powerful: the superstar phenomenon feeds on itself.

  We are all familiar with the Matthew effect in pop culture, where it is so apparent that it seems as inevitable and unremarkable as gravity. Celebrities are famous for being famous. And fame is its own achievement and currency. One reason we know that is because of fame production machines, like reality TV shows, and the intense popular desire to participate in them. (In Philadelphia in August 2007, twenty thousand people competed for twenty-nine spots on American Idol, a far tougher ratio than being admitted to Harvard.)

  Here’s what might surprise you: The intrinsic power of superstardom—making an impact because of who you are, not what you do—operates not only in the skin-deep world of entertainment. It also applies to what we like to think of as the empirical universe of science. In fact, the term “Matthew effect” was coined by sociologist Robert Merton to describe how prestigious awards, in particular the Nobel Prize, influenced the perception of scientific work. Merton discovered that science had its own superstars, and that those stars’ discoveries were considered more important or original just because of who had made them.

  Merton found that scientists who published frequently and worked at “major” universities gained more recognition than scientists who were equally productive but worked at lesser institutions. In cases where several researchers made the same discovery at roughly the same time, the more famous scientist was usually credited with the breakthrough while his or her unknown peer became “a footnote.” Writing more than four decades ago, Merton predicted that the superstar phenomenon would accelerate, partly because science was at the beginning of a shift from “little science,” with an investigator and a microscope, to “big science, with its expensive and often centralized equipment needed for research.” The superstars, he believed, would be the only ones to get the tools to do “big science,” giving them a further advantage relative to their less recognized peers.

  What is striking about Merton’s scientific superstars is how conscious they are of the inequities of the celebrity from which they benefit. One Nobel Prize–winning physicist pointed out: “The world is peculiar in this matter of how it gives credit. It tends to give credit to [already] famous people.” A Nobel Prize–winning chemist admitted: “When people see my name on a paper, they are apt to remember it and not to remember the other names.” Another physics laureate went so far as to worry he was getting kudos for discoveries made by others: “I’m probably getting credit now, if I don’t watch myself, for things other people figured out. Because I’m notorious and when I say [something], people say: ‘Well, he’s the one that thought this out.’ Well, I may just be saying things that other people have thought out before.”

  The scientist who best exemplifies the self-fulfilling power of fame is, ironically, the one most of us would immediately name as the twentieth century’s brightest example of pure intellectual genius: Albert Einstein. Einstein was indeed a groundbreaking physicist, whose theory of relativity ushered in the nuclear age and transformed the way we think about the material world. But why is he a household name, while Niels Bohr, who made important contributions to quantum mechanics and developed a model of atomic structure that remains valid today, or James Watson, one of the discoverers of the double helix structure of DNA, is not?

  According to historian Marshall Missner, Einstein owes much of his power as one of the most influential me
n of the twentieth century less to his theoretical papers and more to the trip he made to the United States in April 1921 as part of a Zionist delegation led by Chaim Weizmann. Before the ship made landfall, Einstein was already known—and feared. His theory of relativity, first put forward in 1905, had been dramatically confirmed in 1919 by the observation of the deflection of light during the solar eclipse in May of that year. The discovery captured the American popular imagination, but not in a good way. The twenties were a fraught decade. The Bolsheviks were consolidating their power in the Soviet Union. Germany was struggling under the weight of punitive World War I reparations. The U.S. economy was still booming, but income inequality was higher than it had ever been and elites were frightened both of homegrown populist protesters and of revolutionary ideas crossing the Atlantic. It was also a time of intense xenophobia and mounting anti-Semitism.

  In that climate, America’s arbiters of public opinion decided that Dr. Einstein and his theory of relativity were sinister and subversive. It became a truth universally acknowledged that only “twelve men” in the world understood the theory of relativity. Pundits worried that this small, foreign cabal could use its knowledge to bend space and time and to enter a “fourth dimension” and thereby achieve “world domination.” Even the New York Times warned of “the anti-democratic implications” of Einstein’s discovery: “The Declaration of Independence itself is outraged by the assertion that there is anything on earth, or in interstellar space, that can be understood by only the chosen few.”

  Then came the Weizmann delegation. Zionism was growing in popularity among New York Jews, and thousands came to the pier to greet the visitors. But the press thought the crowds were Einstein groupies. The Washington Post reported there were “thousands at pier to greet Einstein.” The New York Times wrote that “thousands wait four hours to welcome theorist and his party to America.” Its interest piqued, the press pack descended on Einstein. Instead of the “haughty, aloof European looking down on boorish Americans” they had expected, he turned out to be a modest, likable guy who “smiled when his picture was taken, and produced amusing and quotable answers to their inane questions.” No longer a threat to the Declaration of Independence, “Professor Einstein,” the New York Times editorial page declared, “improves upon acquaintance.” The scribblers loved him, and they loved the frisson of overturning their readers’ expectations, and a scientific legend was born. From that moment on, a great deal of Einstein’s power in the world, particularly outside the lab, but also within it, was derived from his celebrity.