Is Wall Street Extractive or Inclusive?

I mentioned earlier how Why Nations Fail is one of my favorite books of the last few months. It’s not perfect, but I’ve found its ideas to be very useful in clearing away some of the ideological shrubbery from around various issues. Briefly, the thesis of the book is that countries succeed or fail in the modern world not based on their policies, religion, agricultural heritage, disease load, or other factors, but based on their political institutions. Successful countries have “inclusive” institutions, where property rights are secure, innovation is rewarded, and elites are restrained from corruption and self-dealing. Failed countries have “extractive” institutions, which are basically looted by their elites. Property is taken or given at the whim of the politicians, corruption and self-dealing are rampant, there is no incentive to innovate, and so the country remains poor.

Obviously this is a spectrum, not binary categories, as some institutions are mixtures of extractive and inclusive. But this is a great way to simplify a lot of otherwise too-complicated debates. For example, with the election heating up, people have been focused on Bain Capital, and private equity generally, debating back and forth about whether or not the industry is good for the country. The debate usually gets quickly down into the weeds of tax policy and whatnot, but this extractive/inclusive spectrum is what we’re really talking about.

Conservatives insist that when Bain bought some company which later collapsed and stiffed all its pensioners, it was just “creative destruction,” a clearing out of dead wood, a necessary sacrifice to the free market demiurge. And you know, it’s not immediately obvious that they’re wrong. According to Noah Smith, Japan has laws which make it exceedingly difficult to take over a company, and the result is a lot of sclerotic, dysfunctional companies, and low productivity. On the other hand it’s also easy to imagine destruction that isn’t remotely “creative.” Surely it’s possible for rich people to take control of a company and bleed its life into their own pockets through financial trickery, or abuse of political influence, or manipulation of tax loopholes, etc. Back in the Gilded Age, financiers like Jay Gould were infamous for doing this through stock-watering and the like.

Obviously once we’re clear on this distinction someone has to actually do the yeoman work and figure out exactly what kind of policies we need to prevent extraction. For my part I’d say the vast majority of financial “innovation” has been in the direction of more extraction, and we need a bunch of dumb, blunt, sledgehammer rules aimed right at the pelvis of the financial sector that keep it small, weak, and boring. Even if I’m wrong there, the financial sector still deserves outsize caution, due to their tempting position astride the money streams of the world.

At the minimum, when they break the law, they should be punished severely.

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Ryan Cooper

Ryan Cooper, a contributing editor of the Washington Monthly, is currently the Washington correspondent for The Week.