By Eric Beinhocker

“Four men sat at a table. Raised sixty floors above the city, they did not speak loudly as one speaks from a height in the freedom of air and space; they kept their voices low, as befitted a cellar.”

The four men in this early scene from Ayn Rand’s Atlas Shrugged are magnates of the steel, mining, and railroad industries who along with their lobbyist meet in “the most expensive bar-room in New York” to foil the book’s entrepreneurial hero, Hank Rearden, and protect their oligopolies. They conspire to use their influence in Washington to stitch up markets, crush competitors, and stifle innovation. They cynically clothe their plot in arguments that they are protecting “the public interest” and promoting a “progressive social policy.”

Ayn Rand would likely be deeply unhappy with the state of American capitalism today. Not just because of an overweening state, large budget deficits, and interventions in the economy such as Obamacare—the issues that so excite her disciples in the Republican Party today—but also because of the morphing of the U.S. economy into a playground of crony capitalism recognizable from the pages of Atlas Shrugged. Rand would have seen the growing reliance of businesses on Washington for corporate welfare, and of politicians on businesses for campaign contributions, as an unhealthy codependency that distorts the free market she so admired.

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The profits of firms in more than 40 percent of the U.S. economy—in sectors such as agriculture, financial services, real estate, oil and gas, health care, education, and defense—are deeply intertwined with and at least partially dependent on policies in Washington. Various studies show enormous returns on investments in lobbying—for example, the pharmaceutical industry reaps a return of 77,500 percent on lobbying versus 8 percent from actually making drugs. While Rand would have had many differences with the Occupy Wall Street protesters, she would have found common cause with their objections to the power of the K Street lobbyist-industrial complex.

The Rise of the Rentiers

Economists use the phrase “economic rents” to describe extraordinary profits that arise from distorted, uncompetitive markets. In a truly free and competitive market, there are no “rents,” only market returns. Rentier capitalism is a system in which the focus is not on creating, making, investing, and building, but on distorting, protecting, skimming, and getting a slice. Rand’s villains were just as often rentier capitalists as welfare “moochers.” The rise and continued support of rentier capitalism is perhaps the final remaining point of bipartisan cooperation in Washington. Democrats and Republicans alike dole out spending, preferential treatment, and regulatory gifts to favored industries and constituents, all oiled by ever-looser campaign finance rules. This creates space for horse-trading—a defense contract for my district in exchange for support of your regulatory break for financial services. Such horse-trading cuts by interest group rather than along party lines.

Fortunately, however, objections to the growing distortions in American capitalism are also increasingly bipartisan. Since the Lehman Brothers crash in 2008, the left has vociferously criticized the cozy relationship between the financial-services industry and Washington—from Matt Taibbi’s memorable Goldman Sachs-vampire squid analogy in Rolling Stone, to the self-immolation of Bush Administration officials in the documentary Inside Job, to the megaphones of Occupy Wall Street.

But perhaps the most extensive argument against rentier capitalism has come from the right. In his 2012 book, A Capitalism for the People, University of Chicago economist Luigi Zingales makes the attention-grabbing argument that the United States is increasingly becoming like his native Italy, where success isn’t based on what you know but who you know. We may not be having bunga-bunga parties in the White House yet, but Zingales leaves one feeling they can’t be far off. Zingales describes himself as a “pro-market populist” and argues for lobbying limits, financial reform, regulatory simplification, tax reform, reinventing antitrust law, greater transparency, and more equality of opportunity. There is much in his agenda for both the center-right and center-left to agree on.

In a similar vein, Charles Koch (as in “the Koch Brothers”) published an op-ed in The Wall Street Journal titled “Corporate Cronyism Harms America.” While his language is not as colorful as Taibbi’s, his overall point is essentially the same—when business and government interests collude in a corrupt system that distorts incentives, bad things happen. The Journal chose to illustrate Koch’s piece with a cartoon of a grinning Uncle Sam and a corporate fat cat carving up a large turkey together. Standing to the side is a lean and hungry-looking man holding out an empty plate. He might well have been labeled “The Middle Class,” for it is the middle class that has lost the most in the great American turkey carve-up.

Failing to Invest in the Middle Class

The facts about the decline of the American middle class are increasingly familiar, though startling nonetheless. After growing almost continuously since World War II, U.S. median income stagnated at the end of the 1980s and then, beginning in 2000, declined 11 percent. Middle-class incomes today are no higher in real terms than they were in 1987.

Much of the debt that caused the crisis was accumulated by the middle class as people tried to compensate for stagnant incomes by mortgaging up their homes and running up their credit cards. Then the debt bubble burst and the median family lost nearly $50,000, or 40 percent of its net wealth, from 2007 to 2010. For the typical middle-class family, the crisis wiped out 18 years of savings and investment. With too much debt before the crisis and their modest savings hammered by the downturn, many middle-class baby boomers are facing a major decline in living standards as they age. On the other side of the generational divide, this will be the first cohort in modern American history whose children will quite possibly be poorer than their parents.

So what do the rise of rentier capitalism and the hollowing out of America’s middle class have to do with each other? It is too simple to say that one directly caused the other. But they are more tightly linked than might be expected. The usual explanations for the woes of the American middle class point to big tectonic forces—namely globalization and technological change. At a superficial level this argument is correct—competition from low-wage countries has depressed wage growth in certain sectors, and technology has eliminated some manufacturing and middle-management jobs. But what this analysis leaves out is what we didn’t do—we didn’t make the long-term investments that would have helped us better adapt to these tectonic shifts.

One of the great historical strengths of both American capitalism and the American political system has been their adaptability. When the Industrial Revolution threatened America’s largely agricultural economy, America adapted and went one better, leapfrogging European industrial production by the early twentieth century. When industrialization then unbalanced America’s political system and strained its social fabric, Teddy Roosevelt unleashed a wave of political and social innovation, busting up trusts and introducing protections for consumers and workers. In the depths of the Depression, another Roosevelt responded with rural electrification, the creation of Social Security, and financial regulation that kept the system stable for 70 years. When the Soviet Union challenged America in the Cold War, we made massive investments in technology, education, and the National Highway System. The benefits of these innovations and investments flowed broadly in American society, not least to the middle class.

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Where are the innovations and investments that will enable today’s middle class to meet the challenges of our own era? While government spending has risen relentlessly over the past decades, what we have not been spending on is our future. The Economist Intelligence Unit, the research arm of The Economist, recently ranked U.S. education performance seventeenth out of 50 developed economies. If one takes out spending on the War on Terror, government investment in R&D as a percentage of GDP has declined over the past two decades, while Chinese investment has more than tripled and will pass ours in the next decade. And according to the OECD, the United States now ranks sixteenth in broadband penetration, speed, and price. Flying from run-down John F. Kennedy Airport in New York to Beijing’s gleaming new airport terminal, one wonders which is the developing economy.

One should not see this short-termism as only a problem of government. The private sector has also lost much of its ability to think and invest for the long term. Starting in the 1980s, elite business schools began teaching future managers and investors that the only metric that matters is shareholder value. This was a dramatic change, as throughout most of its history American capitalism had operated on a stakeholder model in which managers sought to balance the interests of multiple stakeholders, including investors, customers, employees, and local communities. The shareholder-value revolution created a short-term quarterly earnings culture, a bias toward sweating assets versus building them, a view that employees are a cost to be managed rather than human capital to be invested in, and a love of debt. It also made CEOs and their top managers immensely rich by showering them with stock options. While CEO compensation shot upwards, corporate debt levels climbed, R&D spending dropped, and employee churn and temporary work rose.

Some might reply, what about Apple, Google, and Facebook? Don’t we still have plenty of innovative companies? Yes, we still have Silicon Valley and other pockets of entrepreneurship that are the envy of the world. But it is important to note that Silicon Valley was built by and continues to live off of the long-term investments of an earlier era—whether it was the government contracts that enabled Fairchild Semiconductor to launch the microchip revolution and spawn companies such as Intel, or DARPA’s invention of the Internet that made Google and Facebook possible, or Bell Labs’ early investments in cellular communications that lurk beneath every Apple iPhone. And yet Silicon Valley does not an economy make. Facebook, the most successful startup of recent times with a market value $60 billion, employs fewer than 5,000 people. Most of Apple’s job creation has been in China.

So it is true that America’s middle class has been under pressure from global competition and technological changes. But it is also true that America has not been investing enough in education, infrastructure, and technology to equip our middle class to compete in a more challenging world. Short-term rent-seeking and political gain have been driving out long-term investment.

Middle-Out Economics—True American Capitalism

Ayn Rand would have deplored this mutation of American capitalism. It is the opposite of the entrepreneurial, risk-taking, meritocratic capitalism she celebrated. In a twist of historical irony, the narrative that justifies this mutation is one of free-market conservatism. Just as Rand’s villains in Atlas Shrugged justified their market carve-up with cynical arguments about “social progress” and “public service,” today’s rentiers justify their actions by citing Rand, Hayek, and Friedman, claiming it is “the free market at work.” So when a bank threatens to trade against its own client unless the client steers it new business with fat fees—something Tony Soprano might have called “protection”—bankers call it “the efficient market at work.” Or when the clubby board pays its CEO handsomely despite mediocre performance, it claims it just reflects the “global market for talent.” Or when a lumbering corporate giant gets a tax break, it calls it “promoting entrepreneurship.”

Perhaps the most insidious narrative has been that of “trickle-down economics.” It has created the myth that helping powerful plutocrats is somehow the same as encouraging the free market. Orwell would have admired the doublespeak. But the true history of American capitalism has not been “trickle down,” it has been “middle out.” More than a century of private- and public-sector investments made American workers the most productive in the world. As labor productivity rose, so too did wages, creating the largest and most prosperous middle class the world has ever seen.

Middle-out economics is a principle that Henry Ford understood when he decided to pay his workers enough so they could afford to buy his cars. Entrepreneurs start companies not because of tax breaks, but because there are consumers out there who want and can afford what the entrepreneurs make. And most entrepreneurs don’t start rich; most start in the middle class or below. Steve Jobs’s father, Paul, was high-school educated and his mother was a payroll clerk—they struggled to send Steve to college. Sam Walton’s father was a farmer, and Walton started his business with $5,000 saved from his Army pay and a loan from his in-laws. Neither of these entrepreneurs would have benefited from tax breaks for the rich. Think of all the potential Steve Jobses and Sam Waltons who didn’t make it because their parents couldn’t afford to send them to college or because they couldn’t get a small-business loan. Government doesn’t make entrepreneurs, but it can help them help themselves.

Trickle-down economics may work in textbook economic theory with ivory-tower assumptions about perfectly rational people and perfectly efficient markets. But in the real world of politics and interests, it simply provides a cover story for rentier economics. It dresses up anti-market behavior in free-market rhetoric.

Other have presented Middle-out economics as a progressive argument—but it can just as easily be presented as a conservative argument. It is a call for a return to a truer form of American capitalism. It is an argument for going back to the values that have described American capitalism since de Tocqueville—competition, meritocracy, equality of opportunity, innovation, risk taking, and reward for hard work, self-improvement, and fair play. Both Randians and modern conservatives such as Koch claim to disdain rentier capitalism and celebrate these values. But what Rand’s acolytes, Koch, and the Tea Party fail to see is the constructive role government must play if these conservative values are to be made real. This is not the heavy-handed interventionism or disdain for markets by socialists or the far left. This is the enabling and investing role of government supported by generations of both centrist Republicans and Democrats.

Rand argued that the masses need elites. But elites also need the masses. In Atlas Shrugged, a grasping state causes the elite to go on strike, with dire consequences for the world. In America’s current case, a grasping elite is in danger of strangling the middle class, with consequences potentially as dire as Rand’s dystopian vision. It will take deep reform and a reassertion of the political center, but America can move away from rentier capitalism and return to the middle-out capitalist model that has served it so well. If not, there are a billion middle-class Chinese, Indians, Brazilians, and others who will only be too glad to take over America’s lead.

Originally published at here.

10 August 2015