Inside Job

  So, yes, there was unquestionably enormous hubris, greed, stupidity, and dishonesty in the George W. Bush administration. But, tempting as it may be, blaming everything on the Bush administration is deeply wrong, and it misses the main point.

  Because the main point is this: over the last thirty years, under the Democratic Party as well as the Republicans, America’s politicaleconomic system has lost its way. There have been occasional episodes of real progress such as the Internet revolution; and in some areas, such as theoretical computer science and entrepreneurial high technology, America remains unmatched. But the dominant underlying trend has been, and remains, severely negative. America has quietly become a profoundly different place, with its economic competitiveness, its basic fairness, the education of its population, and its politics all in sharp decline.

  Economic power in America has become far more concentrated, both structurally and individually. Structurally, several of America’s largest industries and the American economy as a whole have become far more concentrated since deregulation began. We have already seen this with regard to financial services. But the same thing has happened in energy (the four largest oil companies), telecommunications (AT&T, Verizon, the cable industry), the media (which overlaps with the cable and entertainment industries), retailing (Walmart, Amazon, etc.), agribusiness and food (McDonald’s, Yum Brands), and other industries, even information technology.

  In part this trend towards consolidation has been caused by the Internet and information technology, which allow the efficient management of much larger organizations covering wider markets and geographical areas. But in large part, this trend has been the result of corruption—corporate money that neutered antitrust policy, the political system, and the economics discipline. In many industries that have sharply consolidated or have been concentrated for a long time—including financial services, car manufacturing, telecommunications, and the media—there is absolutely no reason to believe that higher concentration brings higher efficiency.

  In fact, the evidence points in exactly the opposite direction. Many of the most successful foreign industries that have overtaken America’s—cars, telecommunications, and consumer electronics, among others—were less concentrated than America’s. If GM had been broken up long ago, forming two or three firms that really had to compete, the American car industry would almost certainly be in better condition. Unquestionably, such concentrated power also contributes to income inequality. Large firms in concentrated industries have much more bargaining power relative to employees and suppliers. Walmart, McDonald’s, and other huge firms are famous for being brutally tough on their suppliers, forcing them to cut costs, and also for their opposition to unionization of their enormous, low-wage, retail workforces, who often have very difficult working conditions.

  Nonetheless, the structural concentration of American industry has continued over the last thirty years. At the same time, economic power in the US also became more concentrated at the individual level, with a small number of households owning the majority of financial wealth and providing a high fraction of individual US political campaign contributions.

  The combined result is that we are increasingly controlled by an amoral oligarchy that has progressively corrupted the US government and political system, including both political parties. This political corruption has in turn further entrenched the wealthy and the financial sector, and has now become a major driver of economic and social decline.

  The wealthy are safe from the effects of this decline, at least for now; indeed, they have benefited from it, because they have skills, financial assets, mobility, and political power. They are also increasingly insulated by parallel, private systems for education, security, infrastructure, and financial services. The absence of significant political or social protest in response to these changes, the Occupy movement notwithstanding, has emboldened them to continue. At the same time, and in part as a result of these changes, the bottom two-thirds of the population has become less educated, less informed, less prosperous, angrier, and ever more cynical about its political leadership. There is good reason for this cynicism. In their stomachs, most people know that their leaders are lying to them and that the system is rigged.

  When America started its economic decline in the 1970s, Americans’ first responses were simply to work longer hours and go into debt. But after a confused, failed reform attempt by President Jimmy Carter, American politics turned increasingly to demagoguery and corruption. The political system’s response, particularly among Republicans, was to pretend that the problem was taxes and excessive government, while hypocritically using deficit spending and financial bubbles to cover up America’s long-term problems. Democrats made vaguely progressive noises but did little about them, while giving ever more to the financial sector and the wealthy. But those options are wearing thin and will eventually be exhausted. Unless America reverses course, things will end badly, at least for the bottom 90 percent of the population, and possibly even for the wealthy who consider themselves safe, with effects that will ripple across oceans, to Europe and elsewhere.

  This is the first time that the US has faced a combination of structural political corruption, rising inequality, and long-term economic decline. And so far, American politics has mostly been producing decisions that make things worse, not better—and are economically and politically unsustainable.

  We are entering a dangerous zone. On the one hand, excessive concentration of power tends to produce an echo chamber, in which those at the top only need to deal with each other. There is less pluralism, less competition, a narrower range of options and views, less room for manoeuvring. Companies have more power, because there is less choice; it’s harder for employees, suppliers, and customers to talk back to them, or threaten to switch. This isn’t healthy.

  But in addition, this economic decline will inevitably produce increasing social pressures. Economic and social insecurity can produce activism for reform, but they can also produce anger, desperation, and dangerously simple solutions. They encourage nasty charlatans to distract public opinion from real challenges in favour of stupid, extremist, counterproductive measures—or simply doing nothing.

  The deterioration is now systemic and structural, and it is causing the unthinkable to become possible. Until the global financial crisis, the “great recession”, and the Eurozone debt crisis, nobody would have believed that Europe faced a serious risk of financial crisis, possibly accompanied by major social and political instability. But now it is clear that Europe does face these problems. And not so long from now, America could too.

  For reasons explored below, the American national system—the combination of educational and economic opportunity, farsighted government policy, freedom of debate through an independent press, an academic system that provided critical analysis of self-interested arguments, and two-party political competition that kept the US mostly prosperous and dynamic for many decades—has come undone. This has destabilized, and yet paradoxically also frozen, American politics; when you look below the surface, since about 1980 there has been a frightening continuity in political behaviour. With each decade, US government policy under both political parties has tilted ever more towards the financial sector, the very wealthy, and the most powerful, most concentrated, and frequently most inefficient or damaging industries in the US.

  There is also, undeniably, a cultural dimension to this. Middle class and working class people have become increasingly scared, frustrated, angry, cynical. Some demand reform, but many others want a return to a simpler, more secure, more traditional time. They are susceptible to extremist politics and religion, and to fake promises of easy prosperity, whether coming from preachers, politicians, or bankers. Many others have just given up, not bothering to vote or pay attention to politics at all. In this environment it has proven all too easy for politicians, who are so easily hired by America’s new oligarchy, to exploit popular anger and fatigue while actually delivering oligarchic policy. Republ
ican Newt Gingrich attacks government after being paid $1.6 million to lobby for Freddie Mac; Mitt Romney pretends that the financial crisis was caused by excessive regulation; and their archenemy, President Obama, promises reform while protecting Wall Street.

  On balance, the Republican Party has produced the worst, most flagrant behaviour, but this has become a thoroughly bipartisan process. In fact, some of the most destructive policies leading to the financial crisis were initiated by the Clinton administration, not by George W. Bush, and some of Bush’s most destructive policies were supported by many congressional Democrats. More recently, Barack Obama has chosen both personnel and policies stunningly close to both the Clinton and Bush administrations, and in some ways even worse. Obama has brushed the mud off the same dishonest and discredited people, kept the financial sector’s privileges and incomes intact, avoided prosecution of financial crime, and done almost nothing about the home foreclosure crisis and the millions of families who owe more on their homes than they are worth. (As of 2012, about 20 percent of American mortgages were still “underwater”.)

  Perhaps worst of all, the Obama administration has done nothing to address the long-term decline of the economy. It has said little, and done less, about growing inequalities of income and wealth, the deterioration of public education and educational opportunity, the predatory criminality of the financial sector, or the many ways that money now corrupts American economic policy. As soon as he took office, Obama quietly dropped his reformist, activist campaign rhetoric in favour of claims that recovery was under way and all would be well. As the 2012 election approached, he started to move back towards the reformist rhetoric, but without actually doing anything.

  In short, when it comes to the central issues facing the American economy, both parties are moving in the wrong direction. The noisy arguments that dominate the headlines are sideshows. On the critical questions, America’s new rulers are calling the tune. What is going on here?

  In May 2009 Simon Johnson, an MIT professor and former chief economist of the IMF, published a powerful article in the Atlantic Monthly magazine entitled “The Quiet Coup”. Johnson catalogued the uncontrolled growth of America’s financial sector and its toxic consequences, warning that the US was starting to look dangerously like an emerging market oligarchy (or to say it less pleasantly, a banana republic, a third-world dictatorship), complete with sovereign debt problems, financial crises, bailouts of the rich whenever they mess up, and caste-like divisions between rich and poor. Johnson pointed out that often this process ends with the oligarchy overreaching itself so severely that financial crisis leads to depression, which in turns leads to political revolution. For America to avoid this fate, Johnson argues, it must break up its largest banks and reassert control over the financial services industry.

  My own view is that in one way things are more hopeful than Johnson suggests, while in others he actually underestimated the problems, because they go beyond the financial services industry.

  On the hopeful side, I believe that America is still a sufficiently open and democratic society, however imperfectly so, that when the American people finally decide they have had enough, change will be possible. The numbers—at least the numbers of people—are on the side of reform. It isn’t even really the financial industry that is on the other side; it’s the financial sector’s elite, the fifty thousand people who make the serious money and control the companies. This is not an insurmountable opposition. And, several times in the last half century, we have seen citizens’ movements that successfully brought about major political change from below, even when the main political parties initially paid no attention. The civil rights, women’s rights, and environmental movements come to mind. Popular anger can even remove a president and his entire administration, as history saw with Richard Nixon and his cronies after Watergate. I think the major reason that money-driven politics has succeeded for the past several decades is simply that most of the American people are not yet angry enough, not yet aware of just how badly they have been taken. Many others are too cynical to use the established system but not angry enough to make the system change.

  On the other hand, we face two problems beyond those Johnson mentions, and which complicate reform efforts. First, as I will describe in more detail below, America’s political parties and governmental machinery have been hijacked in a very clever, powerful way that defies easy remedies. In 2010 I coined the term “political duopoly” to describe this situation, in which the two political parties agree to disagree violently on social issues while both serving the new economic oligarchy and blocking the rise of strong third parties and reform efforts.1 Economic decline and the new oligarchy are therefore more resistant to popular activism than was (and is) the case with regard to, say, discrimination against women or environmental pollution.

  And second, our problems go beyond any one industry. While the financial sector has unquestionably become the most powerful and dangerous industry today, it isn’t alone. For much of its deregulatory agenda, the financial sector has important allies, particularly in the telecommunications, energy, media, health care, and industrial agribusiness/food industries, as well as several thousand ultrawealthy families. These people share the financial sector’s desire to translate their wealth and cohesion into political power in order to shelter themselves, their families, their personal assets, and their industries from competition, prosecution, effective regulation, proper corporate governance, and taxes. They can even count on substantial support from people who run honest businesses but who still benefit from lower taxes and less regulation.

  But this situation is not merely unfair; it is economically disastrous. The least-discussed but perhaps most important effect of money-based politics is that it has caused government policy to shield incompetent and/or predatory industries from internal reform and competitive discipline. This problem goes far beyond finance, and is critical to understanding not only the financial crisis but also the broader economic decline of the past decades.

  General Motors and Chrysler didn’t go bankrupt just because of the financial crisis in 2008; they went bankrupt because for decades previously, they had been in unchecked managerial decline. They were run by incompetent, lazy, insular, selfish managers, with no interference from their complacent boards of directors or the antitrust authorities—and, indeed, with the frequent assistance of US government policy. They should have been broken up or forced to reform their corporate governance long ago. But they weren’t, and we all paid for it—literally. The same was true earlier of other once domestic industries, such as steel and consumer electronics, that failed so completely that they have largely disappeared from the national economy. As we shall see shortly, the same is now true of telecommunications. The telecommunications oligopoly is retarding progress in America’s broadband infrastructure, an extremely dangerous situation given the role that Internet services now play in economic performance. So although the financial sector is the most obviously dangerous part of the new oligarchy, it is not the only one contributing to the overall decline.

  In the remainder of this book, I shall examine first the causes, and then the implications, of our recent political-economic decline. Then I will describe the emergence of America’s political duopoly—the system by which both the Democratic and Republican parties are now dominated by the new economic oligarchy, and how the parties handle this situation strategically. I will examine the consequences of this situation, including the Obama administration’s personnel and policies. I will then consider the current and future determinants of economic competitiveness, using US broadband communications, Internet services, and information-technology hardware as examples. Finally, I will offer some ideas about what the future holds, what the most critical goals for reform are, and whether we can pull ourselves out of this morass.

  I will begin by examining the beginnings of American industrial decline in the 1970s, and how America’s major industries responded to this decline. Faced with growing chal
lenges, America’s business elites found a cheap way out—one that has turned into our biggest problem.

  Explaining Decline: The Destabilization of the American National System Since the 1970s

  WHY DO WE see, over and over, the cyclical rise and fall of companies, national industries, nations? The British Empire, General Motors, U.S. Steel, Microsoft, the United States—we see the same pattern over and over again. An initially small, powerless company or nation devises a superior way to run itself; it becomes enormously successful, vanquishing all rivals; but then, at the height of its apparent power, it begins to decay from within. It starts to coast. It becomes lazy, politicized, complacent, dysfunctional, corrupt; and eventually, after a period of internal decay, it collapses under its own weight or falls prey to some aggressive new competitor.

  The US has now entered such a systemic decline, and the rise of the new economic oligarchy and money-based political system is both a cause and a symptom of it. As is typical in such situations, the decline of America’s political and economic systems began at the height of national power. Money-based politics was not the initial cause of the decline, but it was the way that America’s largest industries responded when they were threatened. It turned out to be easier and more effective (more effective for them, not for the country) to pay people off than to undertake real, painful, internal reform.

  The initial source of this decline was the complacency of American industry, permitted by the concentration and global dominance of what then constituted the core of the world economy. In part because World War II had devastated most potential competitors, and in part due to the enormous size of the US domestic market, American industry faced no serious competition, either foreign or domestic, for a quarter century after the war. During this time, America’s largest and most important industries gradually became complacent, rigid, highly inefficient oligopolies or even in some cases monopolies. They also came to have complacent, low-quality corporate governance and, in some cases, unions that contributed to systemic rigidity. They were not attuned either to innovation or to competitive threats, either domestic or foreign. Many senior managers also deliberately resisted innovations that would have rendered their skills obsolete, and would have reduced their internal power and status.