Tuesday, October 29, 2002

Krugman, Lewis and greed

The New York Times Magazine has given the cover of its last two issues to what it calls The Class Wars. The first story, by Paul Krugman, glossed the growing inequality in the US, and bemoans the fact that "income inequality in America has now returned to the levels of the 1920s." The second piece, by Michael Lewis, was headlined "In Defense of the Boom," and takes a contrarian stance with regard to the late-90s technology bubble. "If your measure of social progress is corporate profits, it is easy to take a dim view of the boom," writes Lewis. "It is more difficult to do so if you step back a bit and survey the bigger economic picture."

Adam Moss, the editor of the magazine, decided to pair the articles off against each other, with the successive covers of the magazine running photos from the same shoot: first of all a robber baron kicking a working stiff out of the picture, then the same working stiff dragging a handcuffed robber baron off to jail. In case the pictorial rhetoric wasn't enough, the headline on the cover of the second magazine was "The Vilification of the Money Class".

But in fact you'll look in vain for any defense by Lewis of the obscene pay packages that Krugman attacks. While Krugman hasn't drunk nearly as much of the New Economy kool-aid as Lewis has (see this 1997 Slate article for an example of his skepticism about such things), the fact is that the two writers are simply looking at two very different aspects of the 90s boom.

Krugman concentrates on the increasing inequality in individual wealth and pay, pointing out that top executives earned less than one fifth of their present salaries as recently as 1987, "the year Tom Wolfe published his novel The Bonfire of the Vanities and Oliver Stone released his movie Wall Street". Lewis, on the other hand, looks on the excesses of the 1990s with a kind of detached wryness. "It's more than a little nuts for a man who has a billion dollars to devote his life to making another billion, but that's what some of our most exalted citizens do, over and over again," he writes. "That's who we are; that's how we seem to like to spend our time. Americans are incapable of hating the rich; certainly they will always prefer them to the poor."

Lewis's main thesis is that the technology boom did wonderful things for the way companies were organised, for the way they were financed, and, not least, for the economy as a whole. If we now start looking back on those days as an evil era of stock manipulation and systematic shafting of the little guy, then we risk losing sight of all the good things we had, including "the depth, breadth and extent of wealth-sharing" in technology companies. The fact that so many employees had such great stakes in their companies, says Lewis, helped not only to spread the wealth around; it also gave companies a means to structure their payroll in such a way that employees got paid more in good times and less in bad times. In consequence, says Lewis, the number of layoffs was minimised.

Lewis even takes the argument one step further, using the example of his own purchase of Exodus shares at the height of the boom. "What happened to my money?" he asks. "It didn't simply vanish. It was pocketed by the person who sold me the shares." That person, he goes on to say, was, more likely than not, a working grunt at Exodus Communications. The foolish speculator (Lewis) got fleeced for his greed; the noble worker got the cash.

Michael Lewis is bright enough to know that he's only telling one side of the story here. For one thing, employees in the technology boom didn't hold nearly as much stock as he likes to make out. They held stock options. That's a very different thing, because options skew the incentive structure. If a manager holds stock worth $100 and considers a risky maneuvre which could send the stock to $110, he has to weigh the 10% return against the risk that the whole company could be endangered. But if the manager holds options to buy the stock at $95, then his return becomes 200%: worth a lot more risk. What's more, the interests of the manager (boost the stock as much as possible, as quickly as possible) aren't necessarily aligned with those of shareholders (make sure the upside on the stock exceeds the downside).

And yes, Michael, when people say that $7 trillion (or whatever) in stock-market value has vanished, they're right. It hasn't passed from middle-class speculators with too much cash to people who were lucky enough to sell at the top of the market. It's vanished. Yes, the money which was spent on buying shares at the top was also given to people who sold shares at the top. But the vast majority of shares were neither bought nor sold anywhere near the top. If a portfolio manager bought a million shares of Exodus at $20 and marked his position to market every day, then at the top he had made $140 million on his investment. And when Exodus went bankrupt, that $140 million was gone, along with the intial $20 million. Vanished. Into nobody's pocket at all. So when Lewis writes that "stock market losses are not losses to society. They are transfers from one person to another," he is simply wrong.

Lewis also gets things right, of course. Yes, the bubble wasn't the fault of Merrill Lynch, or even of Wall Street in general. And Lewis is a dab hand with the aphorisms: "By forcing Merrill Lynch to agree that its advice was corrupt, Eliot Spitzer helped the firm avoid saying something much more damning and much more true: that its advice on the direction of stock prices is useless. Always. By leading the firm to the conclusion that it had misled the American investor, Spitzer helped it to avoid the much more embarrassing conclusion that the American investor had misled Merrill Lynch."

What he means is that the middle-class masses looked at the vast amounts of money being made in technology stocks and got greedy. They started wanting to get in on the act too, and they forced Wall Street to play catch-up – not with the venture capitalists, so much as with the taxi-driving day-traders. Cue another Lewis aphorism: "That's the odd thing about the present moment: it is widely understood as a populist uprising against business elites. It's closer to an elitist uprising against popular capitalism."

This is the point at which we can take the Krugman and the Lewis articles and find some kind of synthesis. How can they both be right – Lewis that the boom years were mainly driven by the little people, and Krugman that the little people got very little from the boom years, and that nearly all of the benefits accrued to those at the very top?

The answer is that while Krugman is right about the what – there is, indeed, much more inequality in the US economy now than at any point in living memory – he's wrong about the why. Krugman discounts Sherwin Rosen's "superstar hypothesis" – basically, that, increasingly, we're in a winner-takes-all economy – in favour of something rather fuzzier to do with societal norms, corporate culture, and the evaporation of any guilt that executives might have once felt about paying themselves untold millions of dollars per year.

Krugman then goes on to say, basically, that the great unwashed are really stupid, and will quite happily believe whatever rich people want them to believe. "In addition to directly buying influence, money can be used to shape public perceptions," he writes. While that might be true to a certain extent, I don't think it's the main, or even a main, reason why policies which benefit mainly the top 1% of the population continue to receive such widespread public support.

Rather, it's worth recalling Lewis's comment at this point, that Americans will always prefer the rich to the poor. And also recall this month's Harper's Index, where we find this:

Percentage of U.S. college students who believe the “next Bill Gates” is among today’s generation of college students: 50
Percentage who say they are the next Bill Gates: 24

People support policies which benefit the rich not because they are rich, but because they believe that they will be rich. Voting Republican is like buying lottery tickets: it hurts the poor, but the poor do it in much greater numbers than the rich.

It's not just that Americans are a naturally aspirational nation, although that's part of it. It's deeper than that: it goes all the way back to the American Dream. The whole point of being an American, for most of its citizens, is this: that anyone can make it. And even those who have statistically negligible chances of ever doing so not only believe that they can, but also believe that they will. And when they get there, goddamn it, they will have earned it. And there's no way that they want the government taking their hard-earned fortune away from them.

And with this in mind, we can now revisit Lewis's thesis that the 90s boom was a bottom-up affair, a grassroots movement, if you will. He's right: the day-traders who fuelled the rocket-like ascent of the stock market were not the hedge-fund elite, but rather the aspirational poor. And Krugman's right, too: those day-traders didn't make any money at all. The people who made money were people like Jeff Bezos and Michael Bloomberg, Wall Streeters who had enough money even before they started their respective companies to live comfortably for the rest of their lives.

But the billions that Bezos and Bloomberg made shined like beacons for the population as a whole. They weren't disgusted by them, the way that Krugman is; rather, they were hypnotised by them. As the pot of gold at the end of the rainbow became bigger and bigger, the desire for it grew proportionately. There was no outrage because it wasn't theirs, it was mine, if only.

So Krugman's right: the rise in inequality was indeed fuelled by greed. But it wasn't the greed of the new plutocrats, so much as it was the greed of the whole mass of the US population. And Lewis is right too: that very greed financed technological investment and innovation which is sure to help the economy as a whole, even if it never repays the original investors. But that doesn't justify the fact that the top 1% of the population got the lion's share of the economic benefits of the boom.

Posted by Felix at 1:21 EST

Comments

just as a point of fact, you're wrong about stock market losses. unless you're talking about spectacular bankrupcies, of which we've seen fairly few, investments in stocks don't disappear. it's transferred wealth, from the buyer of a stock to the seller. even if you have a real liquidation, stock holders still have claims on any remaining assets, although admitedly small ones. but in general, money adheres to the financial equivalent of the second law of thermodynamics: it simply doesn't disappear. the assets you hold can decline in value, but that's a different matter altogether.

Posted by: Matthew at 19:26 EST, November 01, 2002

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