Selected Chapters from:

Wealthy Elites, Crises and Economic Democracy. New Alternatives Beyond Neoliberal

Capitalism

Andrés Solimano

*Do not cite or reproduce without the author’s permission

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Chapter 1. Introduction and Guide to the Book

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Since the 1980s and 1990s we live in a variant of capitalism --dominant in the US, the UK,

Russia, to an extent in China, Chile and a score of other countries -- that embraced policies of

privatization, market deregulation, globalization, denationalization and financialization as the

engines for growth and modernization. This variety of capitalism, often called neoliberalism,

shows the following main features: (i) in prevalence, in really existing capitalism, of

monopolistic markets, dominated by oligopolies and big conglomerates in key economic

activities, (ii) the legitimation of the profit motive over other motivations such as solidarity and

altruism as the fundamental mechanism to encourage wealth creation and redistribution , (iii) a

reduced role of the state as producer, regulator and redistributive agent, (iv) a significant

concentration of economic power and political influence in small but powerful economic elites,

in other words a strong dominance of capital, (v) a weakening of the influence of labor unions

and a decline of labor shares in national income, (vi) a control of the mass media and other

mechanisms of knowledge production and dissemination by private interests and economic

conglomerates, (vii) a democratic process of low intensity with reduced citizen participation and

strongly permeated by the influence of big money and interest groups.

The adoption of neoliberal policies has been accompanied, in the economic and social

realms, by irregular growth paths, large inequality of income and wealth, a sharp internal

differentiation of the middle class generally considered as a stabilizing segment in society, the

fragmentation of entrepreneurship, an increase in the frequency of economic and financial crises,

the globalization of elites and a rise of migration in highly segmented global labor markets.

The leading actor of the new play is rich economic elites. This segment, popularized as

“billionaires” by publications such as Forbes magazine or the top 1 percent, has strived in

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dynamic sectors of the economy such as technology, finance, telecommunications, energy,

media, entertainment and others. In today´s capitalism, the very rich control most of the

productive and financial wealth of society. Their influence not only reaches the material realm of

the economy but is also extended to the sphere of ideas, culture and the production of a

“common sense” aligned with the views of the elites. As mentioned before, private

conglomerates have dominant ownership of the mass media (TV, newspapers, radio networks)

and other centers of production and dissemination of knowledge and cultural contents that shape

social behavior and political views that are functional to the status-quo.

A countermovement to the increasing power of economic elites in the new global capitalism

has been the emergence of national and global social movements that are critical of corporate-led

globalization, social inequality and exclusion, unemployment, corruption and the failures of

representative democracy captured by interest groups and self-reproducing political and

technocratic elites. We live in fragile and complex times. On one side, there are unprecedented

technological breakthroughs and new productive possibilities to raise living standards and, on the

other side, we experience uneven growth, social tension in divided societies, ecological fragility

and climate change.

The growing influence of the rich economic elites on democracy is a source of concern.

Given their unparalleled capacity to appropriate the economic surplus generated in an economy

with new and more productive technologies these elites are able to mobilize ample financial

resources to influence the working of political institutions and, thus, block or neutralize, real or

perceived, social demands for higher taxation, and regulation of big business and, even,

nationalization of the assets concentrated by the elites, although some “business friendly”

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nationalization of banks in the US and UK actually took place during the financial crisis of 2008-

2009.

There are several channels through which the money of the elites exerts a decisive influence

on democracy. To cite the most important: (i) contributions by corporations and rich individuals

to political campaigns, (ii) lobby activities to affect legislation, (iii) the ownership, funding and

shaping of messages by the mass media and the advertisement industry, (iv) the mobilization of

public intellectuals and academics to provide technical arguments in favor of pro-elite policies.

Nowadays the most important corporate decisions concerning investment, remunerations of

CEOs, middle rank managers and workers, location of firms are made in the opacity of corporate

boardrooms, which are accountable only to a small group of dominant stockholders. The lack of

economic democracy of current society is, indeed, large. Consumers, workers and community

members are, notably, outside the small circle of decision makers, although they are, of course,

directly affected by the decisions made by economic and political elites.

This book examines the main impacts of neoliberal capitalism on the formation and

consolidation of business and financial elites, the fragmentation of the middle class, the

diminished role of labor, the frequency of financial crisis, the increased globalization of elites

and talent mobility along with the rise of social and protest movements around the globe. The

book also explores the scope for greater economic democracy as an alternative to elite-

dominated capitalism.

1. The Different Phases of Capitalism since the 19th century: Laissez-Faire,

Regulated and Neoliberal Capitalism

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From an historical perspective, capitalism has undergone different phases in the last two

centuries or so. In the “long 19th century”, say from around 1815 up to 1913 right before the First

World War, in Europe and the New World (USA, Canada, Australia, New Zealand) the dominant

form of capitalism was laissez-faire: unregulated, relying on self-correcting markets operating in

the framework of a liberal state of low taxation, reduced business regulation and the gold

standard (at least in the later decades of the 19 th century in several countries). In its international

dimension this was a global capitalism that promoted free trade, unrestricted capital mobility

and, to a large extent, free migration.

In the long 19th century, the hegemonic power was Great Britain that practiced a sort of

“imperial free trade” based in its colonial system, better technology, economic power and naval

superiority and liberal economic doctrine. As noted by Karl Polanyi the period from 1815 to

1913 was historically unprecedented as it yielded, on the whole, international peace in Europe

based on a balance of power system among various empires.

Nevertheless, the outbreak of World War I completely shattered the world-system of liberal

capitalism. The breakdown of the previous economic and political order brought about by war

was followed by more than two decades, until the end of World War II, of economic and

political turbulence. The early 1920s were characterized by very severe inflation in Austria,

Hungary and Germany and by a difficult return to the gold standard. The attempts to restore

orderly trade and capital mobility were ultimately futile. A severe financial crash took place in

1929, followed then by the Great Depression and an uneven and bumpy recovery that only

consolidated through the economic stimulus provided by the war effort. The 1920s and 1930s

were two decades of social turbulence characterized by the emergence of virulent and destructive

nationalisms, xenophobia and intolerance in the forms of Fascism and Nazism.

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Towards the end of World War II, the USA and the UK, the two main global powers, gave

priority to a new political and institutional settlement oriented to stabilize global capitalism,

curbing its most self-destructive tendencies and consolidating international peace with the help

of the newly formed United Nations, whose headquarters were placed in New York City. In turn,

international monetary stability and orderly adjustment to balance of payments disequilibria was

the mission of the new International Monetary Fund (IMF) with headquarters in Washington DC.

In turn, assistance for economic development and reconstruction would come from the World

Bank. The IMF and World Bank became part of the Bretton Woods system, under the strong

influence of the US government. The Bretton Woods system, however, was not truly global as it

did not include the presence of the USSR and the full new socialist block.

At national level, the post-World War II economic and social priorities in industrial countries

were the provision of jobs for all, (full employment), economic security and social protection.

These new priorities also reflected the demands of a population exhausted by the instability,

turmoil and economic insecurity of the 1920s and 1930s.

The specifics of the new social contract of regulated capitalism varied from country to

country. In the United States there were the policies of the New Deal led by President Franklin

Delano Roosevelt in the 1930s, and continued, decades later, by the “Great Society” programs of

President Lyndon Johnson in the 1960s. The New Deal included a series of legislation and

commitments by government to ensure full employment, deposit insurance relief to those

affected by the Great Depression, farm support, public work programs and the creation of

institutions to promote housing acquisition by the middle and working class. New labor

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legislation came to place and a Federal system of social security was created to provide income

for retirement along with affordable health services.1

In Europe, several models of social welfare and policies oriented to ensure full employment

were also developed. In Britain the Labor Party, in government after 1945, adopted the

recommendations of the Inter-Departmental Committee on Social Affairs Report, known as the

“Beveridge Report” and expanded the National Insurance System covering pensions,

unemployment transfers and other social benefits, including a labor and tenant covenant and the

National Health System; these programs constituted the bulk of what was the welfare state

system in the UK. In France, in 1944, the National Council of the Resistance (or Conseil

National de la Resistance, CNR) opposed to the Vichy regime and composed by a range of

progressive parties and social movements, including the communists, draw a government

program to be applied after liberation that included the nationalization of energy, insurance

companies and banks, social security, the need for state planning and policies oriented to

guarantee the independence of trade unions. In West Germany, in 1949, after the end of World

War II, the social market economy was led by the Christian Democratic Union under the

leadership of both Economic Minister Ludwig Erhard and Chancellor Konrad Adenauer. This

was a model that combined market capitalism with social insurance. The social balance was to be

guaranteed by the combination of active trade unions to countervail the power of capital. The

German model was intended to be a third way between laissez fair capitalism of the 19 th century

and state-socialism and collectivism of the sort implemented in soviet Russia since the second

half of the 1920s following the Bolshevik revolution of 1917.2

1 The programs existing before were only of partial coverage and in charge of local governments.

2 Decades later, British Prime Tony Blair tried a new “third way” in the UK although this was a sort of “neoliberalism with human face” not very different, in substance, from Thatcherist policies.

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We can summarize the new system of regulated capitalism put in place in America and

Europa after World War II in four main pillars:

(i) Keynesian policies oriented to reduce the economic fluctuations of the business cycle and

ensure full employment.

(ii) The welfare state oriented to provide social protection and access to education, health,

housing and pensions to the majority of the population.

(iii) Controlled private capital markets at national and international levels.

(iv) A reasonable balance of power between organizations representing the interests of

capital and labor unions.

In advanced capitalist countries the regulated system worked fairly well up to the early

1970s. This period was termed as the “golden age of capitalism” due to its economic dynamism

and degree of social stability. In fact, the regulated capitalism was able to achieve reasonably

high rates of economic growth, reduce inequality, maintain macroeconomic equilibrium and

avoid acute social tensions and recurrent financial crises. However, the system was not

completely problems–free either. In fact, by the 1960s the US economy was incubating fiscal

imbalances and divergences between productivity growth and wage increases, which eventually

contributed to seal the fate of the Bretton Woods parity of the US dollar with respect to gold and

opened the door for a crisis of the prevailing monetary system.

2. The Ascent of Neoliberalism.

The term neoliberalism, as mentioned before, denotes an economic paradigm and political

project centered on privatization, market deregulation, reduced economic role of the state,

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financialization and globalization. Its historical origins are associated with the search, in the

1930s and 1940s, of a new liberalism more suitable for a different world to the long 19 th century.

In fact, conservative academic and political circles were disappointed with the dismal economic

performance of the 1920s and 1930s, by the rise of economic nationalism, the growing influence

of Keynesian economics and the rapid industrialization of the Soviet Union. Thus, they decided

to reexamine the conceptual and practical premises of classic liberalism and tried to adapt them

to the new economic and political challenges of the time.

As a first step, a group of liberals gathered in Paris in 1938 at the Walter Lippmann

colloquium to exchange views and organize like-minded people around the quest for a new

liberal approach. Later on, in 1947, the Mont Pelerine Society was formed in a village of that

name near Lake Geneva in Switzerland. Members of that Society included figures such as

Friedrich Hayek, Wilhelm Roepke, Raymond Aaron, Fritz Machlup, Willem Roepke, Milton

Friedman and others. It is fair to say that neoliberalism was, in the 1940s, 1950s and 1960s, a

quite marginalized current of economic thinking with little influence on public policy, even on

conservative governments.

French philosopher Michael Foucault, in a series of lectures given at the College of France in

1978 and 1979 and published under the title of The Birth of Geopolitics, undertook an early and

insightful analysis of several currents of neoliberalism. Foucault contrasted two forces: the logic

of the “reason of state” (raison d´Etat) prevalent in Europe since the 16th century where the state

constitutes both a pre-existing reality and a process of ongoing construction strengthened through

economic, military, demographic and diplomatic means on one side and the quest for setting

limits to the state and the Sovereign on the other. Foucault contrasted 19 th century classic

liberalism and 20th century neoliberalism regarding the relative roles of markets and the state in

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the economy and society and highlighted, in detail, the differences between German Ordo-

liberalism associated with Roepke and Erhard and the Austrian liberals in the line of Hayek and

Von Misses and American neoliberalism associated with the Chicago School of Economics of

Milton Friedman, Gary Becker, George Stigler and others. Foucault draws a critical difference

between the German Ordo-Liberals in both approach and actual policy recommendations and the

American Neoliberals and the Austrian liberals. His accounts, somewhat surprisingly, omits

British Neoliberals.

The Ordo-Liberals saw the market as embedded in a broader framework formed by moral and

cultural constraints that pose social limits to its action. Incidentally, the issue of the

disembodiment of the market in society under liberal capitalism and its dire consequences for

society is a main theme of the classic book The Great Transformation written by Karl Polanyi,

(see chapter 9).

The German social market economy built after 1945, in which the state plays an important

role in the provision of social services and in the regulation of big business and high finance

rested on the recommendations of Ordo-Liberalism. In contrast, Hayek and the Chicago School

saw no mayor need for regulating and constraining the market and advocated for the

privatization of money (Hayek), education, health, social security and the extension of the logic

of the market to a variety of unconventional fields (for the action of the market) irrespective of

the social consequences these extensions of the market could have on the social fabric. For

Polanyi the expansion of the market to create “fictitious markets” (of labor, land and natural

resources) and to social sectors (education, health) was a main cause of social disruption in the

20th century.

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In advising and supporting Margaret Thatcher in the UK, Ronald Reagan in the US and

General Augusto Pinochet in Chile in the 1970s and 1980s, Hayek and Friedman obviously

distanced from Polanyi and completely disregarded the social consequences of promoting the

unregulated market to the largest number of possible sectors and activities for society as a whole.

Different interpretations on the nature of neoliberalism exist. In the neo-Marxian tradition3

the rise of neoliberalism since the 1970s is seen as an economic and political project oriented to

restore the power of capital (capitalist class) after a period of growing ascendancy of the labor

class in terms of strengthened trade unions, higher wages and squeezed profit rates. In this vein,

the stagnationist and inflationary tendencies of the 1970s were, largely, a consequence of the

deterioration of the power of the dominant classes to ensure adequate conditions for capital

accumulation and the appropriation of the economic surplus by the capitalists.

Neoliberalism seeks to restore the appropriate conditions for an increase in the profit rate as a

way to boost investment and growth. In the 1970s and 1980s the adverse “reaction of the

bourgeoisie” to the welfare state, taxation, labor militancy, dirigisme and inclusive social

contracts was unquestionable. Free market economics provided a useful way to revert the process

of diminished business profitability and the weakened influence of capital in setting the rule of

the game in the political and economic realms.

Both Harvey and Demenil and Levy, the main proponents of the neo-Marxian view of

neoliberalism, show the very different nature of the financial crisis starting in 2008-2009 in

advanced capitalist economies compared with the stagflations’ crises of the 1970s that also hit

the core of capitalist countries. In the 1970s the problem was slower productivity growth and

active labor militancy complicated by two oil price shocks (in 1973 and 1979) preceded by the

3 See Harvey, (2005, 2010) and Dumenil and Levy, (2004, 2011).

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end of the Bretton Woods parities. In the crisis of the 1970s, the main problem was that labor

was too strong in the new macroeconomic context of adverse supply shocks and exchange rate

instability.

In contrast, the crisis triggered in 2008-2009 reflected reflected too much of power of capital,

in particular of financial capital. In fact, financial capitalism since the 1980s promoted rapid

credit creation and debt accumulation, with both processes running freely due to a state in a sort

of “neoliberal paralysis” that prevented it to take required measures to regulate, control and stop

financial excesses and rampant speculation. Of course, that state activism would have affected

the interests of the powerful financial elites interested in making money with minimal state

interference.

In fact, since the 1980s, Wall Street, the City of London and other main financial centers

pressed governments not to regulate the loan-making process and the proliferation of new,

complex, financial instruments, a process that ultimately led to financial bubbles and the

overvaluation of asset prices that could not be sustained over time and whose correction proved

to be very costly for real economic activity, employment and the interests of working class and

middle class people.

While financial capitalism came associated with exacerbated income and wealth inequality

favoring financial elites and the super-rich, the non-rich had to incur in indebtedness to sustain

their living standards and afford the increased cost of privately-provided education, health,

housing and durable consumption.

The actual application of neoliberal policies varied among the countries upon which these

programs were implemented. In the third world, a naked and ruthless version of neoliberal

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economics was applied in Chile in the 1970s, under the military rule of General Pinochet helped

by a cohesive team of economists trained at the University of Chicago under the leadership of

Milton Friedman and company. The Chilean experiment was a radicalized version of free market

economics that managed to privatize not only a score of state-owned enterprises in industry,

energy and public utilities but also fully privatized social security (except for the pension system

of the armed forces) through a “capitalization system”. In addition, the profit motive was

extended to education, health and other social activities, a step that Margaret Thatcher was

unable to achieve in the United Kingdom. The political element was important too, as these

experiments in privatization –or “accumulation by dispossession” -- were launched in Chile

during a military regime that ruled without parliament, banned political parties, severely

restrained the action of labor unions and censored the press. The military used active state-

violence to push for the neoliberalization of the country, in a peculiar blend of “closed politics”

and “free market economics”. Furthermore, in another unexpected twist of history, neoliberalism

was further consolidated in Chile by several social-democratic governments (based on a political

alliance between Socialists and Christian Democrats and other center-left parties, excluding the

Communist party) that succeeded General Pinochet in 1990 and that stayed in power for around

twenty years after the end of the military regime (see Solimano, 2012b).

In the first world, the application of neoliberalism by the governments of Ronald Reagan in

the USA and Margaret Thatcher in the United Kingdom was somewhat more constrained by the

presence of democratic institutions, at least if we compare them with the Chilean experiment,

although the crushing of organized labor was not that gentle. Both conservative leaders

deregulated industry, privatized important sectors of the economy, particularly in the UK, and

encouraged private capital markets, curtailing labor unions and strengthening big corporations

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and high finance. In the USA these policies were started by republican administrations and

continued by two democratic Clinton administrations in the 1990s mainly in the financial sector

(the repeal of the Glass-Steagal legislation was led by two Treasury Secretaries of the Clinton

administration: Lawrence Summers and Robert Rubin). As mentioned before, in the UK the

Blair governments of “new labor” also maintained the bulk of free market, conservative policies

started by Margaret Thatcher.

It is fair to say that neoliberalism was more popular, among the policy-circles, in Anglo-

Saxon countries than in continental Europe. Apparently, France and Germany, besides the

Netherlands did not got tempted, at least before the crisis of 2008-2009, to adopt the kind of free-

market policies followed in the USA and the UK. In the Far East, Japan also maintained, on the

whole, a healthy distance from Neoliberal policies although this country experienced a financial

bubble in the 1980s followed by a protracted period of stagnation. As we shall see in chapter 2,

inequality the concentration of income and wealth in the top 1 percent of the population has been

more acute in Anglo-Saxon than in non- Anglo Saxon countries in recent decades.

The reach of neoliberalism also extended to other corners of the world in recent decades. It

sway was strong in Latin America in the 1990 as several countries of the region moved, under

the advice of the International Monetary Fund and the World Bank, to privatize state-owned

enterprises, open their economies to international trade, foreign direct investment and private

capital flows and stabilize inflation. Within the Latin American region, Brazil and Uruguay

maintained a distance from neoliberal economics, while in the 1990s free-market economics was

adhered, with more enthusiasm, in Argentina, Mexico, Peru, Colombia and, of course, Chile. In

the 2000s, however, the political cycle changed again and the governments of Venezuela,

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Bolivia, Ecuador, Brazil, Argentina and Nicaragua adopted more nationalistic and socially-

oriented policies different from the prescriptions of the Washington Consensus.

The influence of free market ideas developed in the West also extended to the former

communist world helped by the action of the US government and the Bretton Woods institutions.

In Russia, the first post-soviet government of Boris Yelstin privatized important parts of the gas

and other natural resource activities, slashed public budgets in education, health and pensions

and fired many people from the state enterprises and ministries. At the top, the replacement of

the old communist-nomenclature elite by a new capitalist oligarchy was bold and swift, radically

altering the existing social structure of the country. The emerging new capitalism tilted the

balance of power between capital and labor in favor of the former, redressing the trend of the

soviet period that was formally a “government of the working class”, of course, ruled by a

communist leadership and bureaucracy.

Primitive accumulation to reinvent capitalism in Russia acquired unexpected new forms.

Former communist apparatchiks and enterprise directors seized very valuable state assets and

resources using obscure and non-transparent mechanisms. The voracity of the new capitalists

was not counter-balanced by the institutions of a hypothetical Russian democratic state as, in the

new ideological and political environment, the state largely resigned to play its key functions of

producer, regulator and (progressive) redistributive agent. Similar trends were observed, with the

corresponding national peculiarities, in Poland, Hungary, Czech Republic, Bulgaria and the

Baltic countries.

In China, the turn to the market since the late 1970s after the death of the father of Chinese

egalitarian communism Mao-Tse Tung was far reaching. In this case, it was the Chinese

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Communist party in power that led a turn-around from near autarky and egalitarianism to a

policy of open doors to foreign multinationals coming, mainly, from the United States and

Europe. Western corporations were eager to transform China into the new “factory of the world”.

In a few decades, the country became a main exporter of (largely light) manufacturing in global

markets taking advantage of the combination of western technologies and managerial capacities

with low local labor costs and the control of the work force provided by an authoritarian state

that could assure to the incoming multinationals a docile and disciplined labor force. Some

authors have labeled as “Neoliberalism with Chinese characteristics” to this peculiar mix of

multinational-led capitalism under communist rule.

3. Impact of Neoliberalism on the Social Structure of Capitalism

The experience, so far, with neoliberalism and globalization highlights four main impacts on

inequality and the social structure of advanced and developing countries.

(1) A sharp concentration of income and wealth at the top. This refers to the phenomenon

discussed at the outset of this chapter and known as the “rise of the top one percent”. In countries

that were pioneers in embracing the neoliberal model such as the United States the income share

of the richest one percent is currently about 22 percent, in the United Kingdom 15 percent and in

Chile it reached a record 33 percent. As discussed before, this trend leads to a worsening of

income distribution and wealth with a sharp concentration at the top, a small group that exerts

disproportionate influence and power on the economy and society.

(2) Heterogeneity of entrepreneurship. Free market economics affected the nature of

entrepreneurship in various ways. Far from turning the economies back to the idealized 19th

century Victorian capitalism of decentralized and atomistic markets depicted in most textbooks

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of economics, it has deepened the dominance of corporate- monopoly capitalism in which the

bulk of investment and production worldwide is carried-out directly, or through global

production chains, by big corporations and multinational firms. These companies, managed by

committees rather than by individual entrepreneurs, enjoy an ample command of financial and

human resources, upgraded technologies, and political influence both at national and

international levels. In contrast, small and medium size enterprises have a lower contribution to

output generation, albeit they are more labor intensive. Entrepreneurship is quite heterogeneous:

on one hand, we have highly successful technological entrepreneurs like the late Steve Jobs, Bill

Gates, and Jeff Bezos, Sergei Brin, Larry Page and others. However, besides the super-stars, we

have a large middle range of “opportunity entrepreneurs”, which create firms and engage in new

endeavors facing limited access to credit, markets and technologies and the harsh competition

and barriers posed by oligopolies and big corporations. In addition, there is a segment of

“necessity entrepreneurs” that operate, mainly, in the service sector and micro-firms, with

reduced financial and technological requirements and very tight access to funding. Necessity

entrepreneurs often earn a rate of return that is not very different from the wage of a middle rank

employee in the formal sector but subject to greater uncertainty and vulnerability. This type of

entrepreneurship is certainly different from the classic “Schumpeterian entrepreneur” and

resembles more an economic survival strategy at times of diminished employment possibilities,

low wages and social exclusion typical of third world countries. Nevertheless, currently,

necessity entrepreneurs are also present, in increasing degree, in core advanced capitalist

economies and peripheral European economies such as Greece, Portugal, Ireland, Spain and Italy

affected by severe economic crises, high unemployment and the destructive effects of austerity

policies.

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(3) Growing internal differentiation within the middle class. The middle class is also a social

segment that has been affected, in various ways, by the turn to the free market, the rise of

inequality and the enhanced power of economic elites. The general trend is toward increased

differentiation within the middle class with some segments of the middle class benefitting from

the new capitalism, while others failing to advance in the free market. On the one hand, we

observe a thriving upper middle class segment composed by a brand of highly educated and

well-connected top managers and professionals such as lawyers, financial experts, economists,

and technology experts working for banks, big corporations and independent professionals firms.

This new “technostructure”, borrowing the highly suggestive term coined by the late American

economist John Kenneth Galbraith, often earns very good salaries and has access to preferential

stock options and bonuses. They make the main decisions within corporations and face appealing

opportunities for upward social mobility in the corporate sector, in government or in the financial

sector.

On the other hand, the new capitalism enlarges a less fortunate segment of the middle class,

composed by school teachers, employees of ministries and public agencies, clerical workers,

salespeople in retail stores for whom free market economics has often meant stagnant wages and

slim chances for economic progress in an increasingly segmented and elitist society. This is a

segment particularly vulnerable to shocks in the labor market (including recurrent waves of job

cuts in the public sector), shocks in financial markets (indebtedness) and, unaffordable, health

contingencies that can be very harmful for their financial position of vulnerable households.

In some countries such as China, India and some Latin American countries social statistics

show that millions of people have left poverty (as measured by income-based poverty lines) and

joined the ranks of the “middle class”. However, in many instances, the new entrants to the

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middle class (itself a complex concept to define and measure as we shall see in chapter 3) are

vulnerable to fall again below the poverty line should an adverse shock take place. Moreover, an

increase in income does not necessarily imply greater economic security, empowerment and

political influence of this “new middle class”.

(4) Fragmentation and Marginalization of Labor. Probably the main losers, in terms of

relative economic position and influence in the economic and political process in the last three

decades, have been manual workers and their organizations. The anti-labor stance of the early

experiments with neoliberalism in the 1970s and 1980s under Reagan in the USA, Thatcher in

the UK and Pinochet in Chile was evident. These governments severely distrusted labor and

engaged often in repressive policies to working class movements. They blamed the alleged

combination of strong labor unions and “large government”, for the slowdown in productivity

growth, squeeze in profit rates, inflationary pressures and macroeconomic instability that marked

the end, in the 1970s, of the post-world war II consensus of regulated capitalism.

A number of changes in the global economy related with international trade, the structure of

production, technological change and the dynamics and institutions of labor markets have

affected the position of labor. We can highlight six major factors at work: First, the increased

globalization of capital such as foreign direct investment and multinationals directing their

operations towards low-wage countries; Second, important changes in the international location

of the production process and the development of global value chains that has encouraged

production and outsourcing of intermediate parts and inputs in cost-competitive nations along

with the externalization of services such as call-centers and accounting; Third raising

immigration of skilled and unskilled workers towards high income nations in North America

and Europe coming from developing countries and former communist nations. This immigration

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flows have increased the supply of labor of various qualifications in host countries bringing

outside competition from foreign workers and professionals; Fourth the penetration of labor-

intensive manufacturing imports produced in low-wage countries that has moderated wage

growth; Fifth, the information technology revolution that has encouraged the adoption of labor-

saving, skill-intensive technologies and reduced the price of investment goods leading to a

substitution of labor for capital equipment including computers, ; Sixth, the diminished

bargaining power of labor unions associated with the de-unionization process . These trends have

had the effect of moderating the growth of wages of workers and middle rank employees,

displaced jobs away from industrial nations, increased wage disparities between CEOs and the

rest of the labor force and increased global inequality. Ian important effect has been the global

reduction of the labor share in national income. Empirical studies are showing that in at least 42

countries during the period 1975 and 2012 there have been a decline in labor shares of the order

of five percentages points, in contrast with the near stability of that share in the four decades

after World War II. Moreover, this decline in the labor share has taken place in the four largest

economies of the world: the USA, China, Germany and Japan. These trends provide evidence of

a regressive distributive shift against labor during the neoliberal era. It is important to note that

this decline in the labor share may underestimate the true increase in inequality in this period if

we consider the sharp rise in remuneration of top income earners (CEO and other senior

managers) that are also part of labor incomes (see chapter 2). In the USA the decline in the

overall labor share in the last 25 years is around 6 percent but if consider the labor share of the

bottom 99 percent taxpayers that decline is 10 percent.4

4. Economic and Financial Crises and Austerity Policies 4 See Karabarbonuis and Neiman (2013) for the evolution of global shares and Elsby, Hobijn and Sahin (2012) for the labor share in the USA.

21

Besides these effects on the social and economic structure of countries, during the last

decades of the 20th century and the early 21st century we have been living in a period of

macroeconomic volatility and repeated financial crises. Large-scale financial crises were more

frequent in the periphery of the world economy—the “global south”— in the 1970s, 1980s and

1990s although advanced economies also experienced financial crises such as the case of the

Savings and Loans crisis of the 1980s in the USA, the banking crisis of some Scandinavian

countries in the early 1990s, the debacle of the Long Term Capital Markets Fund in the late

1990s, to cite some instances of financial crisis in developed economies. However, now the

epicenter of large scale financial crises shifted north and since 2008-2009 the core of the world

economy composed by the United States and several European countries have been at the center

of severe, large-scale, financial crises that have led to stagnation, unemployment, diminished

expectations for future generations and financial fragility. In a historical perspective this

confirms that global capitalism when accompanied by unregulated financial markets at national

and global levels becomes very prone to experience financial crises of different degrees of

virulence and intensity. As we show in chapter 5, historically, financial crisis of big proportions

and with international ramifications were very uncommon only in the Bretton Woods period.

They were present in the first wave of globalization of late 19 th century and early 20th century

affecting both the center (Europe and the US) and the periphery of the world economy with

financial links with the center; also in the 1920s and 1930s and then, again, in the period of

neoliberal globalization started in the 1980s.

These crises raise important questions on the role of economists and the effectiveness (or the

lack of it) of existing international financial institutions such as the IMF and monetary authorities

such as Central Banks. In particular, an obvious question is why the mainstream economics

22

profession, Central Banks and the International Monetary Fund, with their large teams of

sophisticated economists having Ph.Ds. in economics, failed to anticipate these crises and/or

prevent these crises to occur? It is also relevant to ask the role played by the economic theories

these economists and the organizations that they were working for, used to understand reality

and influence it. Particularly miscarried theories were the efficient market hypothesis, new

classical macroeconomics and the rational expectations school that provide very unrealistic

depictions of how the real world works and that can misguide governments and economic and

financial authorities. An additional question is the role economists have played in generating this

general conceptual confusion?

Besides ideas, interests also matter. The public policy climate existing before the 2008-2009

crises and the type of rescue packages put forward in their aftermath, underscore the big

influence that financial sector elites (bankers, big investors, hedge fund owners and managers

and so on) had on Central Banks, Finance Ministries and governments. These financial sector

elites pushed for weak regulation and a hands-off approach of the financial markets and

promoted the notion that these markets could effectively self-regulate them. However, when the

crises occurred, Central Banks and the Treasury provided quick relief to financial intermediaries

and bailed-out these institutions, on the grounds that they were “too- big- to fail”. As a

consequence of those massive rescue packages the national debt of the crisis countries has

climbed, passing the cost of financial irresponsibility to future generations.

It is apparent that during the booming phase of the financial cycle, gains were privatized.

However, in asymmetric fashion, during the crisis phase of the cycle losses were socialized. In

the financial binge, the “discipline of the market”, in which gains and losses of private

transactions are borne by the market participants, has been conspicuously absent. In turn, the

23

“remedies” to the crises –through the adoption of austerity policies-- have been also very

controversial. Initially, in 2009 and part of 2010, the US and European countries attempted

expansionary fiscal policies to counteract the effects of the decline in private investment and the

slowdown in private consumption on economic activity. This policy, however, was abandoned in

2010 and policy priorities shifted from defending employment and growth to the containment of

fiscal deficits and public debt. As a consequence, economic growth in Europe and America

stalled, increasing unemployment and, along the way, debt to output ratios. Austerity policies

have been particularly detrimental for countries of the European periphery such as Portugal,

Spain, Greece and Ireland. Those nations have experienced record unemployment levels and cuts

in social benefits. A sense of despair is pervasive among the population of these countries. The

full consequences for democracy of the protracted economic crisis remain to be seen.

4. 5. Global Elites, Migration and Social Movements

In late 20th century and early 21st century, the migration of workers is by far more restricted

than trade in goods and services, financial capital mobility and foreign direct investment

(Solimano, 2010). We live now in a world in which multinational corporations and knowledge

elites have become more global in their scope of activities than in the past. People with higher

education levels, knowledge capabilities, social status, connections and access to capital have

become more internationally mobile along various circuits and networks in global labor markets

and global capital markets. International investors move financial capital around the world,

including placing them in fiscal paradises, with relatively little restrictions from governments or

supra-national authorities. There is also an internationally mobile “global technostructure”

composed by high level executives, financial and technical experts, economists and engineers,

lawyers and other professionals that work for multinational corporations (MNCs) in the private

24

sector or for international organizations such as the IMF, the World Bank, the OECD, the

United Nations and others in the international public sector. In these international bureaucracies

incomes are tax-free and employees enjoy a privileged status. Besides the international circuit of

big private or public organizations there is also a degree of mobility of independent

entrepreneurs that do not have the backing of big international corporations and that try their

fortunes in other countries the best they can. As in many things in life, some succeed while

others do not.

Globalization has led also to a significant geographical concentration of individuals with high

education and special talents in rich OECD countries. However, the economic crises of the first

world triggered in 2008-09 and the faster rates of economic growth we observe in several

emerging and developing countries may lead to reversals in the direction of migration of

technological entrepreneurs, professionals, technical experts, medical doctors, graduate students,

scholars and others away from the labor markets in rich countries. Global job markets are

changing fast in response to changes in job opportunities and demographic trends.

At the same time, along with these trends of globalization, concentration of third world talent

in rich countries and denationalization of economic activities we find also immigrant´s

Diasporas that have left their home countries for a variety of factors such as war and internal

conflict, political and ethnic prosecution, economic stagnation and other push-factors. A

distinctive feature of the Diaspora, compared with purely economically motivated migration is

their commitment and attachment to their home countries. Diasporas contribute to maintain

historical identities at times of an increasingly rootless global capitalism. Moreover, as Diasporas

prosper in the host countries they become also a valuable source of savings, capital, knowledge,

wealth, access to technologies and international contacts for their home nations. Remittances are

25

the most visible and important vehicle for transferring financial resources to the source countries

but this is not the only asset that Diasporas can transfer to their home nations. Market contacts,

knowledge and fresh capital accumulated by diaspora members are also valuable factors for

development. However, the mobilization of these assets for the national development of the

home country is not always automatic and needs some activism by governments and civil society

organizations in the home nation.

Finally, along with globalization “from above” led by corporations, banks and rich country

governments there is also a social counter-movement of “globalization from below” comprised

by workers migration and the international movement of the poor. Another phenomenon is the

rise of global, national and local social movements critical of the consequences neoliberal

capitalism on inequality, unemployment, economic justice, the environment and the way

democracy works in their own countries and also more globally.

6. Economic Democracy

The power of economic elites, inequality and the corrosive effects of big money for

democracy that characterizes early twenty-first century capitalism has led to the search of

alternatives forms of organization such as economic democracy. The quest for either more

humane and fair capitalism, or for an effective alternative system, is not new. During the 20 th

century the main models for reforming (or replacing) capitalism such as communism and

“reconstructed” social democracy are not appealing any more.

The recent experience with social democratic governments in countries such as the UK,

Spain, the USA, Chile and Greece often ended up in disappointment as they ultimately

implemented public policies that were very similar to those of neoliberalism. In turn, since 2008,

26

social democratic governments in Europe have not been able to offer clear alternatives to the

socially regressive austerity policies dictated by the Troika formed by the IMF, the European

Central Bank and the European Commission. In turn, in the USA the Obama administration

refrained from adopting policies that could have diminished the power of rich financial elites and

inequality remains high.

Political democracy and economic democracy are two sides of a genuinely democratic

society. In fact, democracy will hardly flourish when economic power and the property of

productive assets, including the mass media affecting the cultural and ideological make-up of

society, is heavily concentrated in the hands of small economic elites. They have the means and

resources to influence the political process in directions to preserve the status-quo and their

privileged position in society while excluding the rest from meaningful social participation and

the fruits of material progress.

In the last part of this book we discuss a renewed agenda of Economic Democracy (ED)

that departs from neoliberal policies; this agenda, in turn, is illustrated with concrete historical

and current experiences of practices of ED includes the following principles and aims: (a)

workers and employees enhanced participation in the workplace, on issues concerning wage

setting, social benefits and working conditions, profit sharing and employee stock option

partnership extended to employees and general participation in the firm’s strategic decisions; (b)

democratic access to housing, credit, banking services and education at different levels, (c) a

more inclusive and democratic pattern of ownership of productive capital in the economy,

including workers–owned and workers-managed companies, communal property, non-for profit

organizations and cooperatives, (d) enabling labor and civil society to have effective voice in the

design and implementation of adjustment programs and austerity policies, (e) public (not

27

necessarily equal to state) ownership of natural resources and other strategic productive assets

along with the democratic distribution of economic surplus and the rents associated with the

productive exploitation of national resources and (f) the proper articulation of a broad agenda of

economic, social, cultural and political rights.

Besides ensuring the technical soundness and political feasibility of implementing these

goals, its eventual application will be crucially dependent upon solving, adequately, the “agency

problem” of finding a social group and political organization with conceptual clarity and

leadership to steer progressive social and economic change and also obtaining the support of the

population for this set of socio-economic transformations.

7. Organization of the Book

The book is organized in four parts that, overall, comprise ten chapters. Part A (chapters 2 to

4) examines the social class structure that emerges after the application of the policies of

neoliberal capitalism. Chapter 2 analyzes the nature of wealthy elites and reviews various

empirical measures trying to gauge their quantitative significance, influence and measures to

curb their power. In turn, chapter 3 discusses various theories of entrepreneurship and reviews

empirical studies related to the nature of the entrepreneur in modern capitalism. The chapter

highlights the importance of the technostructure of the big corporation for decision-making

regarding resource allocation and growth compared with the role of the independent entrepreneur

of the individual firm. Chapter 4 focuses on the fragmentation of the middle class since the

1980s (neoliberal era) between an upper middle class segment and a lower middle class group

and evaluates the potential contribution of the middle class, along with its limits, to spur growth

28

through entrepreneurship, to job creation and to political stability. Part B, comprising chapters 5

and 6 focuses on economic and financial crisis that have shaped global capitalism since the 19 th

century to the present. Chapter 5 provides a review of several historical episodes of financial

crises in the 19th, 20th and 21st centuries, in both advanced capitalist countries and in developing

and emerging economies, highlighting their main causes, mechanisms of propagation and

economic and social consequences. The chapter also considers “austerity policies", as a costly

approach to foster recovery after a crisis episode. Chapter 6 then examines a variety of

alternative theories of crises including Monetarism, Rational Expectations, New Classic,

Keynesian, Marxian and eclectic approaches and provides a comparative evaluation of their

merits and shortcomings.

Part C of the book examines patterns of international mobility of capital, rich elites and

professional and knowledge elites that strive under globalization, calling attention to the rise of

global social movements that are critical of both global capitalism and low-intensity democracy

and examines the main features and potential economic impact of migration Diasporas for home

country development (Chapters 7 and 8). Finally, Part D, composed of chapters 9 and 10, focuses

on an agenda of economic democracy and post-neoliberal transformation. Chapter 9 analyzes the

concept, modalities and potential areas of application of economic democracy and chapter 10

closes summarizing the main messages of the book and highlights possible courses of reform of

21st century global capitalism.

29

PART A. Elites, Entrepreneurs and the middle Class: The top 1 percent and the Rest

Chapter 2. Economic Elites and the Super Rich in the 21st century5

The focus of this chapter is on economic elites and the super rich say a small minority that, as

discussed in the previous chapter, captures a significant share of national income (well above its

numerical importance), controls most national productive wealth and has a significant influence

on the political process and the content of public policies. The study of elites has been

traditionally the realm of sociological studies and other social scientists. Mainstream economics,

given its methodological individualism, has generally stayed away from the topic. However, the

economic importance of economic elites cannot be denied. High-income individuals are expected

to play a role in saving generation, investment, and innovation and also in speculation and rent -

seeking. The dominant practice of the last three decades has been reducing taxes on top incomes

5 This chapter draws and expands from Jimenez and Solimano (2012).

30

and the very rich (in both advanced capitalist economies and developing countries) relying on the

notion that in a market economy the rich is an engine of economic growth through their role in

capital accumulation and innovation. Lowering the return on these activities would just diminish

their productive efforts discouraging wealth creation the argument goes. The issue is obviously

controversial for various reasons. On one hand, it is not clear that the formation of top incomes

correspond always to the legitimate return to effort and talent deployed in competitive markets.

Political connections, social background, favorable tax and regulatory treatment associated with

lobby and campaign financing are all factors that also contribute to amaze big fortunes and

concentrate income and wealth.

The rise of inequality, as highlighted in the previous chapter, is contributing to create social

contempt in most societies with expressions such as the Occupy Wall Street and We the 99

percent in the USA, the Indignados movement in Spain, the student movement in Chile, protest

movements in Brazil and Turkey. These movements point to the fact that the fruits of

globalization and progress go disproportionally to a small elite while the youth face hard times to

get a job (in Spain, Greece, Portugal and other nations) and, thus, face grim prospects of genuine

economic progress.

The voices of social discontent have reached also the ears of some within the ranks of the

super wealthy. This is the case of billionaires such as Warren Buffet in the United States and

others in Europe (but apparently no billionaires in Latin America or Africa share publicly this

stand of their colleagues in advanced economies) have called themselves for a greater

contribution of the super rich to total tax collection and for more fairness in tax systems.

31

Most of the economic studies on inequality have a strong statistical focus and concentrate on

the evolution of Gini coefficients and the ratios between top and bottom deciles or quintiles.

However, relatively little conceptual and empirical work has been done so far on understanding

the motivations of the super rich, their main behavioral patterns and the impact of economic

elites on democracy. A practical obstacle for studying elites is the lack of accurate statistical

information on top incomes and top wealth holders that predictably seek to hide their assets to

avoid possible taxation. Using household surveys to track the super rich is of limited use since

respondents tend to systematically underestimate and underreport high incomes. Standard

income Gini coefficients, (calculated on data from household surveys), will deliver a downward

biased picture of the true distribution of income in society (see Box 2.2, below).

In this chapter we review the concept of elites as developed in the classical literature on the

subject associated with the work of Pareto, Mosca, Wright-Mills, considering also theories of the

capitalist class and financial elites. Then we look at recent empirical work, using data from tax

agencies conducted at the Paris School of Economics, on top incomes shares. We also examine

international evidence on wealth concentration by the super rich in advanced and developing

economies compiled by Forbes Magazine and wealth management companies.

The chapter also evaluates several mechanisms and channels through which economic elites

affect economic development and democracy discussing issues of reward to talent and

innovation, the premium to social and political connections, rent seeking, the operation of

winners take all markets effects and the effects of big money on the functioning of democracy.

Then, we examine the role of maximum wages, the regulation of compensation by executives

and taxation of high incomes as a way to correct severe inequality and conenctration of income

at the top.

32

1. Merit- Oriented Elites, Power Elites and Class-Based Theories of Elites

We can distinguish at least three approaches to elite formation: merit-oriented theories,

power-based analysis and class approaches to elites.

a. Merit-oriented Theories of Elites: The Italian Sociological School

The sociological school is concerned with elites mainly as a description on how societies

work and the way social classes and social groups are formed and interact among them. The

main representatives of the “Italian school” school, or merit-based theories of elites, were

Vilfredo Pareto (1848–1923), an economist and sociologist, and the political scientist Gaetano

Mosca (1858–1941). Pareto put forward a theory of circulation of elites and Mosca (1939)

studied the ruling class. The Italian school held a merit–oriented view of elites. Pareto (1920

[1991]) envisaged elites as “people with exceptional qualities”, thus the merit-oriented concept

of elites. Pareto then envisaged history as a circulation of elites mainly within nations6; his main

concern was not the international circulation of elites more relevant in an era of globalization. In

the Ruling Class, Mosca indicates that the main source of power for the ruling class (elites) is

their superior internal organization, enabling them to “have a disproportionate influence over the

vast majority of society despite their numerically small group”. Superior knowledge and better

organization are key elements for a group to become elite. These authors note that elite rules any

society although the members of these elites may change or “circulate” over time.

b. Power Elites

On the other side of the Atlantic, the American sociologist C. Wright-Mills studied the power

structure of American Society (USA) in mid-20th century and concluded that, although personal 6 Solimano and Avanzini (2012) analyze the international mobility of entrepreneurial, knowledge and political elites.

33

merit could contribute for a person to be a member of elite, the defining element of elite was its

relation to power. In particular, in his book The Power Elite (1956) he distinguished the

economic, political, and military “power elite” in the United States. In Wright-Mills the

economic elite, say CEOs of industrial corporations and banks, investors and owners, were

certainly important but a more complete characterization of the compact of power should include

also the political and military elites.7 8

Wright Mills, implicitly, assumed a large degree of cohesion (in ideas, institutional

participation, lifestyles, clubs and schools attended by the children of the elites and other features

of elite membership) among the different sub-components of the power elite.

The power elite hypothesis, however, was contested both by the “pluralist school” (Dahl,

1967); and the neo-Marxist school (Sweezy, 1968).9 The “pluralists” made the distinction

between a “ruling elite” and a group with potential for political control but that may fail to

actually grab it for lack of internal cohesion (consensus) and for the effects of diversity of

interests within the elite. The pluralists were skeptical of such cohesion in the tripartite elite

scheme of Wright Mills in the America of the 1950s and 1960s. In turn, Paul Sweezy (1960)

argues that the military and political elites are ultimately dependent of the economic elites (in

particular of the capitalist class) that owns most of productive wealth and derives of income from

7 Early on, Thorsten Veblen (1857-1929) focused on the characterization of the business elite and the importance of symbolic (conspicuous) consumption and a culture of leisure to signal prosperity and abundance in the gilded age in the (north) America of the late 19th century and early 20th century.

8 It is apparent the complexities of this important subject that has remained largely dormant –in spite of its importance-- for many years. Besides the links and hierarchies between different sub-elites there is the question of how economic elites are formed (inheritance, social and political connections, talent, access to finance, successful seeking of new ideas and innovations with commercial value) and how elites maintain and increase their position in the highest echelons in society.

9 See Gilbert (2008).

34

that. Sweezy states that the ultimate ruling class is the one that owns and controls national

productive wealth. For him, the distinction between separate and autonomous corporate, military

and political elites would eventually vanish as the economic elite –more to the point, the

capitalist elite -- would be the dominant one.

In a generally sympathetic but at times harsh review of Mills’s The Power Elite, Paul Sweezy

states:

“Perhaps the greatest merit of the Power Elite is that it boldly breaks the taboo which

respectable intellectual society has imposed on any serious discussion of how and by whom

America is ruled. ……[However], because he [Wright-Mills] blurs the whole problem of class

and class relations, Mills fails to throw any but incidental light on the dynamics of the class

system–how people lose high-class status, how new members of the ruling class are co-opted,

and so on. In this connection, he completely fails to understand the role of preparatory schools

and colleges as recruiters for the ruling class, sucking upwards the ablest elements of the lower

classes and thus performing the double function of infusing new brains into the ruling class and

weakening the potential leadership of the working class. It is this aspect of the American

Educational System, involving as it does fairly generous scholarships and other forms of

assistance for the bright poor, which is most often and least deservedly praised as democratic”

(Sweezy, 1960, pp.20, 28) .

c. Class-based theories of Elites

The two more influential figures in the analysis of social classes were Karl Marx (1818-

1883) and Max Weber (1864-1920). Marx defined social classes in terms of people’s ownership

of productive assets and their relation to the “modes of production” (e.g. feudalism, capitalism,

35

socialism, cooperativism and so on) a concept that entailed social relations, technology and

different patterns of ownership of the means of production. Social classes also develop views of

the world or ideologies in function of their place in society and the economic process. Marx, who

wrote mostly in the second half of the 19th century, stressed the existence of two main social

classes: the bourgeoisie (capitalists) who own the means of production and control wealth, shape

institutions and political power and the proletarians that own their labor power and are

disenfranchised. Although Marx did not conduct his analysis explicitly in terms of “elites”,

according to him capitalism would lead to increasing polarization and social differentiation

between wealthy owners of capital on one side and the rest of society on the other.

Max Weber, writing in early 20th century, shared Marx´s notion that social classes were

important and largely determined by their role in production and the ownership of productive

assets. However, Weber created a more complex concept of social class in which prestige, status,

occupation and mobility played an important role. For Weber social class were the main

determinant of the “life chances” of people say their capacity to enjoy a good, secure, prestigious

and enjoyable life style, in contrast with a life of hardship, insecurity and anonymity. Modern

analysis of stratification and social class is eclectic and use insights of Marx, Weber and other

authors. Stratification and class analysis tend to follow a multi-variable approach in which

income, occupation, education level, status and prestige, values, thinking and life-style are used

to define social classes. These variables tend to show a high empirical correlation among them.

2. Financial Elites

In the last three decades or so the financial sector (banking, insurance, and real estate) has

displaced the industrial sector, in terms of economic importance, as leading sector in several

36

advanced capitalist countries and emerging economies. Along with the change in importance of

the financial sector, the new financial elite composed by bankers, investors, managers and the

techno-structure of the financial sector has acquired a leading economic and political influence in

society. In a sense there is a “financialization of the capitalist class” or, in another terms, a

“financialization of economic elites”.

Historically the “money trust” of the late 19th century and early 20th century was also

important in providing funding to the consolidation of corporate capitalism.10 Main financiers,

such as J.P. Morgan, played a critical role in stabilizing the panic of 1907 before the Federal

Reserve System was created in the United States, showing their direct influence in public policy

making. As chapter 4 shows the financial sector elite played an important role in the making of

the crisis of 2008-2009 and also influenced the terms of the rescue programs for banks and

financial institutions in the aftermath of the crisis.

3. Inside Economic Elites: Defining and Measuring the Rich

An important issue for the purpose of analyzing economic elites is how to define, in a

statistical sense, the rich. Box 1 provides some alternatives definitions based on either wealth or

income.

Box 2.1. Defining the Rich

There are several absolute and relative definitions of the rich based on income (flow) or wealth

(a stock) or both. Affluence lines and wealth cut-offs are absolute definitions. Top deciles or

percentiles are, in turn, relative definitions.

10 Bellamy Foster and Holleman (2010).

37

Affluence lines. Similar to the procedure of establishing a poverty line, covering the lower tail of

the distribution of income, we can concentrate in the upper tail of the distribution and define the

proportion of people considered as rich using an “affluence line” above some cut off criteria for

income or wealth (see Sen, 1988). Those above the affluence line can be considered as rich. Like

in the case of poverty lines we can also use a head-count measure of the rich.

Wealth cut-offs. Atkinson (2006) defines the rich as those individuals, or households, whose

wealth is 30 times the mean income per person (e.g. the GDP per capita). The choice of 30 is

based on a rate of return of 3.5 percent per year (long run return on assets). This level of wealth

would generate a stream of interest equal to the mean income per person, enabling a person to

live off the interest (return) on his wealth at an average standard of living. Incidentally, this cut

off level of wealth is similar to the used by wealth-managing companies such as Cap Gemini that

define a rich person as one with a level of liquid wealth (excluding real estate property, cars and

so on) equal to one million dollar. In turn, the super-rich is an individuals whose wealth is equal

to 30 x 30 times the mean income (people would live out of the interest of the interests) and the

mega rich as those with 30 x 30 x 30 times mean income per person. The mega rich in

Atkinson’s definition is approximately equivalent to the billionaires of the Forbes Magazine list.

Top deciles, vengtiles or percentiles. This is a relative definition of the rich. Some empirical

applications identify the rich as those located in the upper tail of the income distribution curve:

say at top 10 percent and the top 5 percent. The top 1 percent or the 0.1 percent would be better

characterized as super rich.

38

Box 2.2. The Gini Coefficient with Very High Income Individuals

Very high-income individuals are often statistically insignificant in numbers (say as a share

of the total population of a country) but their share of national income is significant indeed,

particularly in very unequal countries. In addition, household surveys tend to severely

underestimate the share of top incomes. The Gini coefficient, a widely used measure of

inequality, has the property of being very insensitive to changes at the tails of the distribution; in

contrast, the coefficient is more sensitive to changes in the middle of the distribution. Atkinson

(2007) derived a formula that takes into account the share of the super rich (or top income

individuals) treating them as infinitesimal in numbers. Defining the parameter S as the income

share of top income individuals (say the top 1 percent) and G* the Gini of the rest of the

population (say the Gini of the bottom 99 percent), it can be shown that the “true”, or corrected

total Gini, is approximately equal to G*(1- S) + S. Alvaredo (2010) using the Atkinson

formulation and data for the United States and Argentina shows that the increases of the Gini in

both countries in recent decades can be largely explained by the increase in the income shares of

the very rich that has taken place in both countries. This confirms the sensitivity of the total Gini

to top incomes in spite of the almost nil importance in numbers (but not in income shares) of the

group of the very rich. Therefore using Gini coefficients obtained from household surveys data

that typically ignore top incomes depicts a potentially misleading picture of the true evolution of

the income distribution in countries. In practice, the corrected Gini coefficient can be several

points higher than the standard Gini when income concentration at the top is large and

increasing.

4. Recent work on top incomes

39

Among recent empirical work on the rich we have the effort done by The Paris School of

Economics, PSE for short, looking at the level and evolution of the (pre-tax) share in income of

the top 10, 5, 1 and 0.1 percent using time series data for a large group of advanced (OECD)

economies; the analysis has been also extended to developing countries and emerging

economies. These high brackets would compose the “top incomes shares“.11 Top income shares

provide a measure of the concentration at the top of the income distribution. A novelty of the

PSE- project on top incomes is the use of data on tax incomes released by Tax Authorities

(Internal Revenue Service) in various countries. Tax-based data is not easy to obtain and in some

regions (e.g. Latin America), tax agencies seem reluctant to share this information with

researchers and the population at large. The use of tax data can be considered as an improvement

for gauging greater accuracy in the data on top incomes compared with using household surveys,

although the practice of tax-evasion and tax-avoidance makes tax-based data not completely

problem-free either.

A full summary of the PSE project findings is provided in Atkinson, Piketty and Saez (2011).

Some highlights follow:

(a) An important part of the concentration of income distribution across countries and over

time is not in the top 10 percent or the top 5 percent of the distribution but in the top percentile or

the top 1 percent or even the top 0.1 percent.

(b) During the first half of the 20th century, the USA and UK experienced a fall in top income

shares (with certain ups and downs in the first three decades of the century), followed by a

stabilization in that share until the 1970s. Since then, say in the neoliberal era, the trend is

reversed towards greater income concentration at the top.

11 See Atkinson, Piketty and Saez, (2011).

40

(c) Countries in continental Europe (France, Germany, the Netherland and Switzerland),

besides Japan, avoided, in general, the rise of the top income shares of the last 30 years of the

neoliberal era.

(d) The rise of income concentration at the top also was experienced in large emerging

economies such as China and India that have followed market-oriented and liberalization

policies. A similar trend was also observed in this latter period in Argentina, Portugal and Spain.

(e) Across countries there are substantial differences in the income shares of the top 0.1, top

1 percent and the next 4 percent. A group in which the top 1 percent has an income share over 12

percent (around 2005) includes the United States (above 20 percent), the United Kingdom,

Argentina, Canada and Singapore (see table 2.1). Income shares for the top 1 percent between 5

and 10 percent contain Netherlands, India, Australia, New Zealand, Switzerland, France, Japan,

Finland, Sweden, Spain, Portugal, Italy and China.

(f) Evidence from the PSE project, and other sources, shows that an important part of the

reported increase in inequality in incomes is due to the explosive raise of the compensation of

CEOs of corporations since the early 1980s. Higher salaries, stock options available to

executives, bonuses, profit-sharing and other schemes are behind the raise in executive

compensation. This has created a wider gap between average CEO pay and the salaries of mid-

level employees and workers. This trend has been especially serious in the USA and the UK (see

Irwin, 2008).

41

Table 2.1 Comparative Top Income Shares (Around 2005)

42

Country Top 0.1% Top 1% Next 4% Top 5%

Argentina 7.02 16.75 -- --

Ireland -- 10.3 -- --

Netherlands 1.08 5.38 11.79 (1999) 17.08

India 3.64 8.95 -- --

Germany 4.4 11.1 13.1 (1998) 24.2

United Kingdom 5.19 14.26 14.5 28.7

Australia 2.68 8.79 11.2 (2002) 20

USA 7.7 17.42 15.2 32.6

Canada 5.23 13.56 15.4 (2000) 29

Singapore 4.29 13.28 14.6 27.9

New Zealand 2.51 8.76 12.7 21.5

Switzerland 2.67 7.76 11.5 (1955) 19.3

France 2.48 8.73 13 21.7

Norway 5.59 11.82 11.3 23.1

Japan 2.4 9.2 16.1 25.3

Finland 2.65 7.08 9.5 (2004) 16.1

Sweden 1.91 6.28 11.1 17.4

Spain 2.62 8.79 13.4 22.2

Portugal 2.26 9.13 15.4 (2003) 24.5

Italy 2.55 9.03 12.3 (2004) 21.3

China 1.2 5.87 11.9 (2003) 17.8

Source: Tanzi (2011), Adopted from tables in Atkinson et al, 2011

5. Divergent Evolution of Top Income Shares between Anglo-Saxon versus French

Capitalism.

From the late 1920s to the early 21st century a contrasting dynamics of top income shares is

observed among three main capitalist economies: the United States, France and the United

Kingdom (see table 2.2). In the mid to late 1920s, before the onset of the financial crash of 1929,

the top income share experienced a peak, higher in the Anglo- Saxon countries (USA and UK)

than in France, with the highest share observed in the United States (24 percent). Then a steady

decline takes place in a long period covering the Great Depression, World War II and the

decades of “shared prosperity” (from the late 1940s to the early 1970s). This trend starts to be

reversed, however, in the USA and UK after the neoliberal revolutions of Margaret Thatcher and

Ronald Reagan. The subsequent democratic administrations in the USA (Clinton) and post-

Thatcher Labor governments in the UK (Tony Blair and Gordon Brown) did not abate the new

trend towards higher inequality. In contrast, France since the 1940s under different governments

(either socialist or conservative) has avoided an increase in the income share of the top percentile

that has remained stable around 8 percent (the share in the USA was over 20 percent in 2007 and

close to 15 percent in the UK in the same year). It is apparent that different types of capitalism

may have very distinct patterns of concentration of incomes at the top of the distribution.

Table 2.2 Income Share of the top 10 and 1 percent in France, the United Kingdom and the

United States.(In percent, 1927-2007)

43

Source: Atkinson, et. al. (2011)

6. Top Income Shares in Emerging Economies and Developed Countries.

The trajectory of the top 1 percent income shares are shown in the charts below for advanced

countries and emerging economies, including Argentina, the only Latin American country we

have available and comparable data, so far. The diversity in the dynamics of top incomes share is

evident. As noted before, the stabilization of the share for France since the 1940s is in sharp

contrast with the steady increase since the 1980s not only in the United States but also in Sweden

albeit at a relatively more moderate level than the United States (below 10 percent). The

diversity in top shares is wide; countries such as the Netherlands show a steady decline in the

44

United States France United Kingdom

1927 24 15 18

1937 18 13 15

1942 10 8 12

1972 8 8 7

1982 12 7 8

1992 14 8 9

2002 17 8 12

2007 23 8 14

Source, Atkinson, et.al. (2011).

income share of the top 1 percent since the 1940s, reaching levels hovering around 5 percent

(since the late 1970s).

In the developing world, we observe a consistent increase in the income share of the top 1

percent in Argentina, India, China and South Africa since the 1980s and 1990s. The data suffers

discontinuities in Argentina with missing data from the mid 1970s to the late 1990s, so the

evidence for this country has to be taken with caution. In China the top 1 percent share increases

from a low 2 percent by 1986 to close to 6 percent in 2004; this is a three-fold increase in the top

income share over a period of close to thirty years following post-Mao market-oriented policies

but at levels still modest by international standards. In India the top income share doubles from

below 5 percent around 1980 to close 10 percent in 2000. This trend coincides with the adoption

of market liberalization and privatization policies in India. In turn, South Africa also suffers

missing data but a trend of rising income share for the top 1 percent is apparent in the 2000s.

Finally, increases in the top percentile income share are observed in Italy, Portugal and Spain

since the 1980s in the range of 5 to 10 percent.

45

Argentina China

0

5

10

15

20

25

30

1932 1942 1952 1962 1972 1982 1992 20020

1

2

3

4

5

6

7

1986 1991 1996 2001

France India

0

5

10

15

20

25

1900 1920 1940 1960 1980 20000

4

8

12

16

20

1922 1932 1942 1952 1962 1972 1982 1992

Italy Netherlands

0

2

4

6

8

10

12

1974 1984 1994 20040

5

10

15

20

25

30

1914 1934 1954 1974 1994

46

Figure 2.1 Evolution of Top 1 percent Income Share

Source: Database, Top Incomes Project, Paris School of Economics.

47

Portugal South Africa

0

2

4

6

8

10

12

1970 1980 1990 20000

5

10

15

20

25

1940 1955 1970 1985 2000

Spain Sweden

6.5

7

7.5

8

8.5

9

9.5

1980 1985 1990 1995 2000 20050

5

10

15

20

25

30

1903 1923 1943 1963 1983 2003

United States

0

5

10

15

20

25

1913 1933 1953 1973 1993

7. Top Wealth Holders

The previous discussion focused on the evolution of the income shares of top one-percent.

Now let us turn to the inequality of wealth. The distribution of wealth is often more concentrated

(higher Gini coefficient) than the distribution of income (see Solimano, 2009 for evidence on

Lorenz curves for wealth and income for a sample of 130 countries). Unfortunately no data on

top wealth shares for the same set of countries and time periods are available from the PSE

project or from other sources.

As shown before (Box 1) the definition of high net worth individuals depends on the cut-off

used for identifying a rich person, a super rich and a mega rich person. The cut off used by

wealth-management companies that invest money for rich people can be one million dollars, 10

million, 30 million or a billion.12 As it could be expected, the number of people belonging to

each cohort shrinks as the wealth cut-off goes up.

A source of data for the levels of wealth of the mega-rich or billionaires is Forbes Magazine.

This publication has been collecting data on people with net worth above one –billion dollars as

a threshold for more than 25 years. This group of billionaires constitutes small elite that owns

disproportionate financial and productive wealth in the world economy. Forbes Magazine first

focused on the super-rich in the United States and then expanded it compilation to a number of

countries in different continents. According to this publication, there were 1,210 billionaires in

the world in 2011 that have a combined wealth of U$ 4.5 trillion. Interestingly, it is a Latin

American, Mr. Carlos Slim from Mexico, who heads the list of world billionaires according to

12 An individual with a net worth of at least U$ 30 million is defined as “ultra-net worth-Individual (UNWI)” by

Wealth X an advisory firm based in Singapore (Tanzi, 2011). There are near 63,000 individuals UNWI in North America, 54, 325 in Europe and 45,525 in Asia-Pacific.

48

Forbes magazine over US billionaires such as Bill Gates and Warren Buffet. In contrast with the

gigantic wealth of the 1,210 Forbes billionaires we have over 2 billion individuals living with

less than 2 dollars a day. This provides an indication of the abysmal disparities in the world

economy today. The super-rich has accumulated their wealth in sectors such as the information

technology and communications industry, oil, banking and finance, real estate, entertainment and

other sectors. Apparently, the share of those who have inherited their wealth is not large. The net

worth of the super-rich includes physical and financial assets, real estate, and valuable art objects

(human capital is not included as a measure of wealth).

Table 2.3 shows a list of the 10 countries that have the highest number of billionaires in the

list of 54 countries in 2011. At the top is the United States with 412 billionaires, followed by

China (115), Russia (101) and India (55).

Note that the number of billionaires per capita is the highest in the USA followed by Russia.

Interestingly, among the top five countries there are three emerging economies in the group. It is

worth noting that the BRICS (Brazil, Russia, China and India and South Africa) are among the

top 10 countries that hold most billionaires in the world economy. It is no longer true that high

wealth is a phenomenon only of rich, OECD countries.

Table 2.3 Worldwide top 10 Billionaires by Country (2011)

49

--  World total 1210 100 1.7 100

1  United States 412 34 13.2 4.47

2  People's Republic of China 115 10.6 0.9 19.26

3  Russia 101 8.3 7.1 2.04

4  India 55 4.5 0.5 17.3

5  Germany 52 4.3 6.4 1.17

6  Turkey 38 3.1 5.2 1.07

7  Hong Kong 36 3 51 0.1

8  United Kingdom 33 2.7 5.3 0.89

9  Brazil 30 2.5 1.6 2.75

10  Japan 26 2.1 2 1.83Source. Forbes.com and Wikipedia.

Rank Country/RegionNumber of billionaires

Billionaires per 10M

Share of world population (%)

Share of world total (%)

Source: Forbes.com and Wikipedia.

In turn, in the Latin American context Brazil is the country that exhibits the largest number

of billionaires (30) followed by Mexico (11). Chile is the country with more billionaires per

capita in the region.

Table 2.4: Billionaires in Latin America per Country (2011)

50

Source: Forbes.com

8. Critical Issues of Economic Elites: Heroes of Productive Capitalism or Economic

Oligarchs?

After reviewing empirical evidence on top incomes and top wealth-holders let us turn

now to issues pertaining the origin and legitimacy of big inequality addressing the contribution

of economic elites to the process of economic development as well as its impact on inequality

and democracy.

a. Top incomes and top wealth: what is being rewarded?

A basic question is the following: Is top income and big wealth the reward provided by

competitive markets to individuals for their ingenuity, hard work, bright ideas, innovative

capacities, superb education? In other words, is richness just the proper reward to “talent and

merit” in an economy in which opportunities for economic success are fairly distributed in

51

1 2  Brazil 30 1.6

2 3  Mexico 11 1

3 1  Chile 4 2.4

4 5  Argentina 2 0.5

4 4  Venezuela 2 0.7

4 6  Colombia 2 0.4

Total 51Source. Forbes.com

Rank Country Per capita

rankNumber of billionaires

Billionaires per

10M

society? In contrast, wealth accumulation may not only be the outcome of a clean process of

rewarding hard work and talent by decentralized markets but also the result of privileged class

position, social background, political connections, rent seeking and other forms of non-

competitive behavior. The rather cheerful description of capitalism in Milton Friedman´s

Capitalism and Freedom for example stresses that markets perform a good job in rewarding

those who are more talented, hardworking and successful, and that are willing to take more risks.

They naturally deserve higher pay than those who perform more routine tasks and contribute less

to the generation of value added. The stories of legendary innovators such as Bill Gates and

Steve Jobs among others would illustrate the magic of capitalism that can reward handsomely the

bright ideas and commercial acumen (and some ruthless behaviors against competitors and

consumers as well). These cases of ingenuity and success certainly do exist and is part of the

“wonder of capitalism”. However, these individuals are really outliers and their numerical

importance—albeit not the innovations and wealth creation they have brought about—are small.

b. Privatization, Accumulation by Dispossession and Political Connections

A less rosy picture of capitalism suggests that critical in the formation of economic elites

is the appropriation of valuable assets by different means including coercion in processes that are

often far from competitive and transparent. Marx in Capital discussed the process of “primitive

accumulation” as an important step in the formation of the capitalist system. Historically, this

often involved transforming communal property into private property for example taking land

through the enclosures mechanism, expelling the peasants and transforming them in landless

proletarians that would eventually work for a salary in capitalist factories located in urban

centers. The capitalist subsequently accumulates capital by extracting surplus value to workers

dispossessed of land. In recent times a new wave of primitive accumulation or “accumulation by

52

dispossession” in David Harvey’s (2005) terms, has taken place through the privatization of

public enterprises and common goods such as water and public land in countries that have

adopted neoliberal policies in the UK, Russia, China, India, Chile, Poland, Hungary, Czech

Republic and other countries around the world. Following privatization policies new economic

oligarchies have emerged very fast in several of these countries (in Post –Soviet Russia the new

oligarchs, as mentioned before, were former nomenclature members, a feature common to other

former communist countries). In particular, “inside privatization” of state-owned enterprises in

noncompetitive ways has been especially important in the rapid formation of powerful economic

elites in recent years. In these respects, a part of the building up of big wealth could be

considered also as a reward to the right political connections. Another case is the privatization in

Spain of state-owned companies and banks in the 1990s by socialist governments that led to the

formation of big multinational corporations in telecommunications, (Telefonica), oil and natural

gas: (Repsol and Gas Natural), power companies (Endesa, Iberdrola and Union Fenosa),

privately-owned banks such as Banco Santander and BBVA13 .

A “helping hand” from individuals located in powerful places, through special licenses to

run monopolies, special subsidies, tariff protection or subsidized credits can make the difference

for those wanting to enter the club of the “super-rich” and the people left outside of the new

elites.

In post-socialist transitions and in other nations, a small acquiring minority has benefitted

from privatization of public enterprises and public assets accompanied by low taxes for the rich

and lax business regulation. The new rich formed after privatization now form part of the

billionaires list published by Forbes Magazine. In contrast, the majority of the population does

13 For a detailed analysis of Spanish multinationals and foreign direct investment, see (Chislett, 2011).

53

not enjoy these privileges and have had to suffer lower wages and the curtailment of labor rights

and social benefits accompanying privatization and economic liberalization.

c. Top economic elites as entrepreneurs and innovators

Sometimes the economic elites are identified as composed mainly by entrepreneurs although

it is clear that rentiers are also part of the economic elites. The entrepreneur is envisaged as an

engine of growth given its distinctive talent for combining capital, labour and for entertaining a

vision of opportunities and the prospects for profits (see Schumpeter 1934 [1989]). The critical

role of the entrepreneur according to Joseph Schumpeter is making innovations such as

introducing a new good, a new line of production; open a market in a process of “creative

destruction” in which new technologies and ways of doing business replace the old ones.

Another author that analysed the role of the entrepreneur and managers for effective production

in the presence of uncertainty was Frank Knight. Both John Maynard Keynes and Karl Marx

gave a more qualified and perhaps less benign role for the entrepreneur (the topic is dealt with, in

more detail, in chapter 3).

d. Winners-Take-All Markets

A mainstream rationalization of the very rich is related to workings of the so-called “markets

for talent” that concentrates earnings in a few, highly talented individuals. In this context, small

differences in individual abilities can generate very large differences in pay and reward due to

the presence of increasing returns to ability. This winners-take-all market theory is often applied

to explain earnings in arts, sports, entertainment and other activities involving talent. For

example, the number one tennis player in the world makes an income several times larger than

the second or third player, who can be nearly as talented as the number one who wines and

54

receives the main prize (and the most lucrative advertising contracts). Recently, it is has been

also applied to study the compensation of CEO and high executives (Kaplan and Rath, 2013).

Frank and Cook (1995), in their book Winners-take-all Markets, argued that the lure of high

earnings attracts an excessive amount of talent to these activities compared to what is socially

optimal if the true probabilities of making the big prize (say winning a tournament in tennis or

golf) were known ex ante. This theory also can be relevant for explaining behavior in financial

markets in which the expectation of making large salaries and getting preferential option shares

and large bonuses for making good deals led to excessive concentration of talent in the financial

sector. Incidentally, several billionaires come from banking, hedge funds, and investment

companies in which “financial innovations” are highly profitable. In this case large rewards do

not reflect, necessarily, a positive contribution to create genuine economic value. On the

contrary, high pay in the financial sector may be actually rewarding activities that are socially

disruptive, e.g. financial crises induced by reckless behavior of financial executives that engage

in risky behavior lured by the search for big pay. In contrast, occupations that have an important

social value but whose actual pay is comparatively modest (teachers, public employees, and

physicians in public health systems) may not lure an adequate number of domestic talents.

e. Top economic elites and inequality

High concentration of incomes and wealth in small economic elites are often associated

with significant levels of inequality and a worsening of income distribution. For the reasons

exposed before observed income and wealth distribution in capitalism can be far from socially

optimal and morally fair. In addition, the welfare implications of economic growth and

prosperity are crucially dependent on how these gains are appropriated in society. Evidence of

55

large gains to the top one percent or the top one- thousand in the United States, the United

Kingdom, China, India and to some extent in Argentina among other nations suggests that

changes in GDP per capita can be only a limited indicator of welfare changes in society as a

whole. The reality of recent decades is that economic elites have benefited disproportionally

from the benefits of growth, globalization, technological improvements and prosperity.

f. Top economic elites and democracy

The rise of small and powerful economic elites in the neoliberal era has several undesirable

effects on democracy as well. Some mechanisms through which money affects the political

process in a representative democracy have already highlighted them before in this chapter.

A representative democracy follows the principle that one-person is one vote. However,

political campaigns to elect representatives in parliament or government need money and those

who hold those financial resources have an advantage to influence the political process over the

non-rich. Candidates to elected positions in unequal societies will tend to cater those with

financial resources that enable them to be elected through generous campaign financing. This

behavior may have a greater pay-off than directing their efforts to attract the median-voter as

argued in political-economy theories. In turn, the influence of the mass media is very important

to shape views, values and affect political outcomes. A trend of concentration in the ownership

of TV stations and networks, newspapers and other media in the hands of oligarchies and

economic elites is ongoing in many countries such as the USA, the UK, Russia, Latin America

and other nations and regions. In addition, another channel through which money affects the

political process is interest groups activity and donations by corporations oriented to steer

legislation and regulations in a direction that is favorable to their concerns. Clearly, lobby

56

spending and money-contributions affect the way democracy works and shape the legislation

approved in parliament.

A study sponsored by the American Association of Political Science (“American Democracy

in an Age of High -Inequality”) identifies several mechanisms through which inequality affects

democracy: first, inequality of voter participation: the poor tends to vote less frequently than the

rich in countries such as the United States, second, the capacity to organize in lobby and interest-

group association that seek to influence policy-making is far greater for high paying professions,

managers and wealthy-owners than for workers and low income groups. As governments can be

responsive to lobby activity, policies will be more favorable to the interests of the privileged and

wealthy than to the middle class and the poor. Several of these mechanisms are bound to be

particularly serious in developing countries. 14

The great financial crisis of 2008-2009 affecting the US and Europe and the way it has been

dealt with in terms of massive bailout for banks highlighted the political power of the financial

industry. Besides lobbying congress and government other mechanisms of influence of “big

money” coming from the financial industry include job rotation between government and

financial institutions, the funding of research favorable to anti-regulation stances in think tanks

and universities; and the influence of Wall Street on the media for the propagation of similar

ideas.

9. Curbing the Power of Economic Elites

How to restraint the power of economic elites so that the benefits of economic growth,

technological change and modernization are to be widely shared in society among the whole

14 The impact of plutocracy and special interests on the rise of inequality and the working of the political system in America is well depicted in Sachs (2011) and Stiglitz (2012).

57

population? We can identify two mechanisms for reducing excessive income concentration at the

top.

(a) Setting “maximum wages” and, more generally, regulations and caps on executive pay and

(b) Taxation of top incomes.

a. Maximum-Wages and Regulation of Excessive Executive Pay

A proposal for setting a “maximum wage” has been floated in the past and present,

particularly at times of high inequality, financial scandals and war. In the United States a cap on

top incomes was proposed in the gilded age of the early 20 th century to reduce increasing

inequalities of income. In fact, during World War I, the “American Committee on War Finance ”

supported legislation to enact a 100 percent tax for incomes over U$ 100,000 (of dollars of that

time) to help finance the war effort. 15In 1942, during World War II, Franklin Delano Roosevelt,

supported by the labor unions, proposed a maximum wartime income of U$ 25,000 a year

(equivalent to approximately U$ 350,000 in current dollars). In 1944 the US congress increased

the top tax rate on income over U$ 200,000 to a record of 94 percent (Pizzigati, 2010). Personal

income tax rates for top incomes in the US remained near 90 percent for two decades (until the

mid-1960s). Afterwards, they started a steady decline to reach current levels of 35 percent. In the

1990s and 2000s the explosion of CEO and top manager´s compensation also created demands

for ceilings on top incomes. The ratio between CEO pay and average worker´s salaries before the

1980s in the United States was on the order of 30 or 40 at most. Nowadays this gap could exceed

300 or more (Anderson, Collins, Klinger and Pizzigati, 2011). In fact, the rise of corporate pay

15 In the early 1920, communist party members in the Soviet Union were subject to a maximum wage, the partmaximum. The cap was removed in 1932 as Stalin ruling elites started to demand special perks and privileges.

58

and the role of high variable compensation schemes in encouraging excessive risk taking in the

financial sector have been attributed as a significant factor behind the financial crisis of 2007-08.

In the United Kingdom the High Pay Commission composed by academics, the private

sector, and civil society and workers representatives documented an explosive increase in the

compensation and wages of executives and board members in the 1990s and 2000s compared

with previous decades. In fact, while the ratio of compensation of high executives of

corporations and banks respect to average salaries was in the range of 13-44 in 1979-1980 that

ratio went up to the range 38-113 in the years 2009-2011. The High Pay Commission

recommended keeping a base salary for executives and reducing to a minimum the use of

bonuses and option stocks as means of compensations to these high executives. Other observers

propose that taxpayers and workers representatives should have a seat in the boards of

corporations and therefore exercise their voice and vote in the determination of the compensation

of executives and salaries and benefits of employees and workers (the issue is discussed in

chapter 9 devoted to economic democracy).

There are several arguments against big wage gaps and in favor of income caps and

regulating excessive pay for executives that have been the “bread and butter” of big

corporation’s compensation schemes since the 1980s, mainly in the USA and the UK:

(a) Excessive wage gaps within the firm are demoralizing for the work force affecting

adversely worker´s productivity. Along these lines, both manager theoretician Peter Drucker and

financier JP Morgan argued against ratios of executive pay to worker compensation that

exceeded the ratio 20 to 1 or so.

59

(b) Big wage gaps between top management and middle rank employees and workers affect

standard norms of economic fairness in society and undermine the legitimacy of market

economies. 16

(c) In the financial sector excessive compensation to top executives induces above-normal

risk taking by ambitious managers lured by the prospect of making big bonuses and other

financial prizes. This often led to the deterioration in the quality of loan portfolios and opens the

door for financial fragility and crisis that are fiscally costly and destroy jobs and undermine

social welfare.

b. Taxation of Top Incomes

An obvious mechanism to reduce the command of resources by the very rich and

enable the state to perform some of its redistributive roles is taxation of “high net worth

individuals, HNWI”. Tanzi (2011) provides several justifications. One is the standard taxation

principle of ability to pay (the rich has a greater ability to pay taxes than the poor and therefore

should bear a greater taxation burden). Tanzi calls attention that high incomes may not be the

remuneration corresponding to “genuine and deserved incomes” in the sense of economic

fairness. In fact, HNWI are rarely atomistic players in competitive markets but actual individuals

benefitted by rules, institutions, government practices, monopolies, and restrictions to

competition that leave room for super-normal profits, rents and mega- salaries of managers and

top executives. An example in this direction, already noted, is the excessive remunerations of

CEO and managers in the banking system and hedge funds in the US in spite of their poor job in

allocating capital and taking excessive risks in the run-up to the crisis of 2008-09. Then the same

16 For an analysis using the experience of wage regulations in major sports leagues for executive pay , see Dietl, Duschl and Lang (2010).

60

managers benefitted from bailouts and were protected economically by governments due “too

big to fail” considerations. In the Latin American and post socialist countries privileged access to

property through insider’s privatizations schemes and the granting of special tariffs and

protection against competition in several cases led to very high income and wealth of dubious

legitimacy. Tanzi makes an additional (subtle) argument for progressive taxation: the tolerance

of some extra taxation by the rich as those at the top of the income and wealth ladder are willing

to sacrifice incomes (redistributed to society through taxation) to preserve their high social status

and influence. However, those in the way to the top may be more sensitive to taxation. A

distinction can be made between taxing only very high incomes and taxation of high (but not

exorbitant) incomes. However, in practice, the line between those two categories may not be

easy to draw.

During the neoliberal era personal income tax rates were reduced in the US under Reagan

and in the UK under Thatcher, a trend adopted also by other nations. In the US, marginal income

tax rates for the top incomes went down from around 70 percent in 1979 to 50 percent in 1990

and 35 percent in 2005. In the UK top income tax rates went down from over 80 percent in the

late 1970s to around 40 percent in the late 1980s and have remained at that level thereafter. A

lowering of tax rates for top incomers coincided with increases in the Gini coefficient in both

countries in the last three decades.

c. Taxation in high Inequality Regions: Latin America

Tax systems in regions of high inequality such as Latin America play a very small role in

reducing the structural inequalities of income and wealth of the region. In addition, the trend

61

towards reduced personal taxation observed in advanced economies is also present in the Latin

American region (see figure 2.2).17

Figure 2.2: Evolution of Income Tax (IT) and Value Added Tax (VAT).

(Average Latin America, 1980-2009)*

Source: Forbes.com

Note: Data for 18 países: Argentina, Bolivia, Brasil, Chile, Colombia, Costa Rica, Ecuador, El

Salvador, Guatemala, Honduras, México, Nicaragua, Panamá, Paraguay, Perú, Rep.Dominicana,

Uruguay, Venezuela.

We can identify three main features of the tax system in the Latin American that run against a

redistributive role of the state and their failure to follow fairness criteria. These features are: (i) a

comparatively low total tax burden (share of tax revenues over GDP), (ii) an unbalanced tax

structure between direct and indirect taxes, with a modest contribution of direct taxes to total tax

collection, and (iii) a low level of tax compliance (comprising both tax evasion and tax

avoidance).

The total average tax burden of Latin America is low, not only compared with high-income

regions, but also when compared with other regions, of relatively similar levels of economic

17 Since 1980 to the present, in Latin America the legal income tax rates, both personal and corporate, have experienced a major decline in line with the evolution of tax rates in several other nations around the world. The average maximum rates of the personal income tax in Latin America decreased from 49.5 percent in 1980 to 27.3 percent in 2009. In turn, corporate income taxes rates have declined from 43.9 percent to 27.1 percent between the same years.

62

development. Latin America has the second lowest tax burden in the world after Developing

Asia. When comparing to developed countries, tax revenues in Latin America as a share of GDP,

are near half of the developed economies (18.4 percent of GDP in Latin America, compared with

34.8 percent of the OECD and 39.2 percent in the European Union). 18

The second aspect that limits the redistributive role of tax policy is a tax structure heavily

reliant on indirect taxes, generally less progressive in nature. Indirect taxes (as a share of GDP)

represent a similar share in Latin American (9.6 percent of GDP) as in the OECD and European

Union (11.0 percent and 11.7 percent respectively). However, when comparing direct taxes and

social security contributions, differences are enormous. The direct tax burden is more than 10

points higher in the OECD (14.7 percent) and in the European Union (16.1) than in Latin

America, where it also represents a meager 5.4 percent of GDP.19

Furthermore, one of the characteristics of the personal income tax in the Latin American

region is its reliance on taxation of labor income. However, the greatest potential for reducing

tax evasion and tax avoidance is in non-wage incomes. The preferential treatment of capital 18 However, there are profound differences between countries in the region. Brazil, Argentina and Uruguay have tax burdens closer to the levels of developed regions, representing more than 25 percent of GDP. Meanwhile, and despite recent efforts, in most countries of the region the tax level remains below 20 percent of GDP, with extreme cases such as Mexico and Guatemala, where the tax burden is around 11 percent of GDP.These differences among countries are not only due to differences in historic taxation levels, macroeconomic circumstances, tax compliance efforts and recent reforms, but also to differences in the origin of other fiscal revenues coming from the exploitation of non-renewable resources. Those revenues, in countries specialized in the production and trade of commodities, (oil in Mexico, Venezuela and Ecuador, copper in Chile and so on) represent a high proportion of total revenues reducing in some cases the incentive to get additional tax sources. In Latin America, there are eight countries whose fiscal revenues are more dependent on such income, highlighting Bolivia, Ecuador, Mexico and Venezuela with a share over 8 percent of GDP.

19 The main difference in the composition of income taxes between Latin America and OECD countries is in the level of personal taxation. While the OECD collects an average 9.2 percent of GDP out of personal income taxes the Latin American and Caribbean region collects only a pale 1.5 percent of GDP. In terms of contribution to total income tax revenues in Latin America the share of corporate income tax is 70 percent and 30 percent for personal income tax, while the OECD´s tax structure is the other way around: 30-70, with a much greater share of personal income tax.

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gains in the region limits the collection of non-wage personal income. In fact, capital gains

receive generous preferential treatment in most Latin American countries, where these earnings

are either totally exempt from taxation or are subject to very low tax rates, thus explaining the

low taxation of non-wage income. This can be an important source of taxation of top incomes.

Table 2.5: Personal Income Tax (PIT) and Corporate Income Tax (CIT). (Various Regions, Year

2009)

Regions Minimum Maximum PIT (Low)

PIT (High)

CIT

Latin America (18) 1.52 10.27 10.6 27.1 26.8Caribbean (17) 1.47 5.99 17.5 32.1 31.1East Asia and Pacific (32) 1.19 15.65 9.0 29.0 24.0Central Europe and Central Asia (31) 1.08 2.16 13.3 19.4 15.8Middle East and North Africa (21) 1.21 8.60 10.4 26.0 24.9South Asia (8) 3.22 34.17 8.6 25.7 30.4Sub-Saharan Africa (47) 2.55 19.11 10.1 35.2 30.3Western Europe (20) 0.36 3.97 16.7 39.9 26.1U.S. and Canada (2) 0.20 5.42 12.5 32.0 26.5

Note: numbers of countries in parenthesis

(multiple of GDP per capita)

Taxable income of the PIT Tax Rate (Percentage)

Source: Gómez Sabaini, J.C., J.P. Jiménez and D. Rossignolo (2011).

Maximum personal and corporate tax rates in Latin America starts applying at the threshold of

roughly 10 times the GDP per capita. In contrast, in most developed regions the maximum

income tax rate begins to take effect at levels of 3 to 5 times per capita income (see table 2.5). In

addition, the maximum personal income tax rate applicable in the region (27.10 percent) is not

only inferior to those applied in Western Europe (39.9 percent) and the United States and Canada

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(32 percent), but also lower than those applied in East Asia (29 percent) and Sub-Saharan Africa

(35.2 percent).

Another important limitation to tax the rich is the low performance of property taxes in the

region. To put the performance of property taxes in Latin America into international perspective,

we compare it with the performance of other regions of the world. As shown in Table 2.6,

property taxes in developing and transitional countries raise far less revenue relative to GDP than

OECD countries. In the early 2000s property taxes in OECD countries represented 2.12 percent

of GDP, while for developing countries this figure was 0.6 percent and, for transition countries,

0.68 percent. The trend for revenues in all three groups of countries has been slightly upwards

since the 1970s. The numbers in Table 2.6 suggest that the overall performance of the property

tax in terms of revenue collection (as share of GDP) is associated with the level of economic

development; for example, OECD countries rely more on the property tax than do developing

countries. However, that relationship is not necessarily monotonic and Latin American countries

are found to perform below than the average developing country.

Table 2.6 Property tax Revenues in Representative Groups of Countries (Percentage of GDP)

Source: Jimenez and Solimano (2012)

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1970s 1980s 1990s 2000s*All countries 0.77 0.73 0.75 1.04

(37) (49) (59) (65)

OECD countries 1.24 1.31 1.44 2.12(16) (18) (16) (18)

Transition countries 0.34 0.59 0.54 0.68(1) (4) (20) (18)

Developing countries 0.42 0.36 0.42 0.6(20) (27) (23) (29)

Latin American countries … … 0.36 0.37… … -8 -10

In parentheses () numbers of countries

* T he data for 2000s is for five years from 2000 to 2004.

Note: Figures in parenthesis represent the number of countries considered in each computation.

Source: Bahl and Martinez-Vazquez (2008) and ECLAC.

Table 2.7 presents the measures of property tax performance for some Latin American

countries. Even though the reliance on the property tax is low, there is still a significant degree of

variation across countries. For example, in Peru property tax revenues in recent years (2005-07)

represent 0.16 percent of GDP, while in Bolivia for the same period that figure is about four

times larger, at 0.62 percent of GDP. The relative importance of property taxes has decreased

over time. There are also some cases where property tax performance has consistently increased

over time, like in Brazil, Colombia, Ecuador and Guatemala; while in Mexico property taxes

have represented 0.18 percent of GDP, without changing since the early 1990s.

Table 2.7: Property Tax revenues in Latin American Countries(Percentage of GDP)

Source: ECLAC on the basis of official figures.

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1990-94 1995-99 2000-04 2005-07

Argentina 0.65 0.62 0.59 0.44

Bolivia … … 0.69 0.62

Brazil 0.37 0.41 0.42 0.44

Chile 0.55 0.65 0.7 0.59

Colombia 0.25 0.46 0.48 0.54

Ecuador 0.1 0.13 0.13 0.14

Guatemala 0.09 0.07 0.14 0.16

Mexico 0.18 0.18 0.18 0.18

Paraguay … 0.36 0.39 …

Peru … … 0.17 0.16

Uruguay 0.52 0.7 0.71 …

Latin American countries 0.34 0.39 0.45 0.42Source: ECLAC on the basis of official figures.

It is apparent the scope for rising taxes on top incomes in Latin America and elsewhere is not

small but some words of caution are needed. First, we have to consider that in a globalized world

economy with capital mobility attempts to raise personal income taxes in one country may

trigger the flight of capital and savings from the high tax countries to lower tax countries.

Second, a move in the direction of increasing top income tax rates have to be accompanied by an

improvement in the efficiency of the tax system to encourage tax compliance and prevent tax

avoidance and tax evasion. Third, the political feasibility of increasing taxes on top incomes has

to be considered. As economic elites have become more powerful in recent years their capacity

to lobby for blocking progressive tax reform should not be underestimated.

10. Concluding remarks

The recent formation of new economic elites has been associated with phenomena such as

globalization, economic liberalization and privatization. The new economic elites are composed

not only by capital owners but also by high-pay executives. Salaries, bonuses, and the increase in

the value of stocks owned by executives are a main factor behind the explosive rise in

compensation of top managers of corporations. The history of how top incomes and big wealth

was accumulated by different individuals in the last two to three decades around the globe

remains to be written. Rewards to talent, political connections and accumulation by

dispossession surely have played important roles in this process.

The high compensation of top executives and the concentration of incomes and wealth in the

top 1 percent or the top 0.1 percent has become an important issue in public debate in recent

years. The data presented in this chapter is showing a trend of increased shares of the incomes of

the top one percent in both Anglo-Saxon developed countries (USA and UK) as well as in large

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market liberalizers such as China, India, Portugal, Spain and Italy among others. In addition, we

observe also a process of rapid formation of billionaires in Russia, China, India and a score of

other developing nations. A general trend towards the shift in economic power to capital and top

managers highlights the excessive influence of dominant shareholders in the board of directors

of corporations and banks in terms of deciding how incomes are divided among the factors of

production that contribute to generate value in firms and corporations.

The chapter also examined the scope and limits for regulating high salaries and taxing the

rich in capitalist economies. We warn that taxation alone, in a globalized world with capital

mobility, lack of fiscal harmonization across countries and fiscal paradises may not be enough to

correct the current trends to high inequality, economic polarization and small economic elite’s

formation. A fresh look at the possibilities for income redistribution and wealth de-concentration

in neoliberal capitalism characterized by increased market concentration, barriers to competition,

protection of big financial conglomerates, weakening of labor unions and civil society

organization and the pervasive political power of the economic elites is badly needed.

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