Law’s Influence Protecting Wealth Growth
Thomas Piketty in Capital in his path breaking book, Capital the Twenty-First Century, by citing to a vast array of data demonstrates that over the long haul capital grows more rapidly than income or the economy generally – his formula is r>g. Starting from that premise, Shi-Ling Hsu in The Rise and Rise on the One Percent: Getting to Thomas Piketty’s Wealth Dystopia, shows the role law plays in distributing wealth. For Hsu, “Piketty [is] missing a huge piece of the puzzle: the role of law in distributing wealth.” The essence of Hsu’s article is that he shows how, in making and administering law, our legal system has failed to focus on the impact law has on levels of economic inequality. Instead, all too often, the focus of the law and the law making is exclusively on the effect on the private interests that would be directly affected by the legal issue presented. He then demonstrates how, absent a specific and systemic focus on economic inequality, law allows, and frequently promotes, the growth of economic inequality.
Hsu starts with the low hanging fruit of the Great Recession. Preceding it was broad financial deregulation that allowed the huge economic bubble to grow and then, of course, burst when it was no longer sustainable. That deregulation provided the financial industry to gain tremendous short term gain without risk ultimately to itself but that laid to waste the economy of the U.S. and much of the world triggering the Great Recession. In one long paragraph, Hsu summarizes a broad array of corporate and finance laws that were enacted in a very short time to set the stage for the crash. He says there is a now a consensus that “the crisis would not have occurred but for some misguided or feckless legal policy. The financial crisis was, at least in the United States, clearly a product of lawmaking. Lax regulation (or probably more accurately, encouraged) excessive risk taking.” In sum, “a large number of finance professionals took unwise risks that were made possible by one or more legal moves toward deregulation.”
Looking back, these laws were disasters just waiting to happen. We can now ask, what were law makers thinking when they deregulated the financial industry? But at the time of their enactment, there appeared to be close to consensus that these changes would allow economic growth to blossom with minimum risk because the invisible hand of the market would restrain undue risk: The risks would be “rational” because capitalism is all about the allocation of private risk. The Great Recession demonstrated beyond peradventure that the “rational actors,” shielded from the downside of the risks they take, will exercise little or no limit to the risks they will take because that maximizes their upside. That is, of course, how bubbles form, grow and then collapse. For the law to allow this to happen is completely irrational social policy. Even assuming that the risks remain private it is simply wrongheaded to shield actors from the downside consequences of the systemic risk they create while allowing them to capture the upside. Despite the disaster of the Great Recession, the Chicago School macroeconomic paradigm continues to prevail so at best reforms have been muted, if not stifled. For example, banks can still securitize and therefore off load the downside risk that mortgages they issue will not be paid. Piketty with the help of subsequent developments of his work, such as Hsu’s, may help overcome the shortsightedness of prevailing microeconomic economic ideology that has done away with macroeconomic analysis of the economy writ large.
As described by Hsu, the externalities generated by the extreme levels of risky behavior allowed and encouraged by macroeconomic theory were imposed on the American people generally, not on those who created the risk. “In 2008 and 2009, nearly nine million Americans lost jobs. . . . Between 2007 and 2010, nine million Americans slipped into poverty. Even those in the lower ninety-nine percent keeping their jobs, their contractions were more severe than it was for the one percent. For them, housing equity accounts for a much larger fraction of household wealth, and the slow rebound in housing prices has dampened their recovery.” Those externalities included much of the business world beyond the financial sector. When the bubble finally burst, businesses outside the financial sector suffered because the credit necessary to run their operations dried up. To save the financial system, the government, and therefore the American people, assumed the private downside risk from those who created it without imposing any costs on its perpetrators. So, the wealthy suffered less than the people generally and they quickly bounced back from any losses they suffered by snaring almost all the economic since the Great Recession ended. “[F]rom 2009 to 2012, an astonishing ninety-five percent [of total income gains] accrued to the top one percent of earners.”
Hsu identifies the underlying fault with how laws are structured, analyzed and operate: The legislatures do not focus on the broader externalities when considering new laws or amendments to existing laws. “[T]he focus of finance and corporations law is to regulate relations among private parties – investors, directors, managers, and perhaps, under the guise of bankruptcy law, creditors. Securities laws are concerned with protecting the integrity of the market. . . .[T]here is little sense in the law that the finance industry and corporations impose externalities upon a broader society, despite their capacity to redirect the flow of trillions of dollars. . . . [L]awmaking and legal scholarship in the area of finance and corporations law seem to be based predominantly on the notion that the only truly interested parties are private ones.”
A shortcoming of Piketty’s is that he limits his description of capital to things – cash, stock, real and personal property. While it has those physical aspects, capital really is power – social, economic and political power. In terms of law, organized private interests push for and get the legislation they seek. Citing Mancur Olson’s The Rise and Decline of Nations, Hsu describes how, “Over time, special interest groups form, they secure enough above-normal wealth, and what is left over is below-normal wealth for everybody else. Once special interests groups gain a foothold, their influence over policy grows, and their gains at the expense of society cumulate.” Organized wealth gets a seat at the policy-making table but also, in part because of the influence of money in politics, influences who the policy makers are at that table and that determines how policy comes to be defined.
Having laid out why law helps capital by protecting it and helping it to grow using the example of corporate and financial law, Hsu then goes on to describe several areas of law beyond corporate and financial law that promote capital growth.. Some examples that Hsu pick are surprising. For example, Hsu demonstrates how adding “grandparenting” exceptions when new legal regulations are enacted protects and enhances the capital of the “grandparents.” Antitrust law, one might think, should work against the protection and expansion of incumbent wealth. But Piketty demonstrates how the legal interpretation of antitrust law has come to have the opposite effect. To prove a violation, there must be a demonstration of a negative effect on consumers. So, if consumers are not directly hurt by the challenged activity of the defendants, then the regulated parties are protected from liability even if their activity exacerbates inequality by protecting the growth of private wealth. Another example is electric utility regulation. As the law has evolved, it has come to focus on protecting the return on private capital rather than the need to provide electric services for the entire community. Guaranteeing a return on invested capital, allows it to grow unimpeded. Hus also describes some areas of law where wealth obviously is protected and enabled to grow unimpeded. The specialized tax treatment of the oil and gas industry is a good example of that.
Obviously, Hsu cannot in a single paper describe how law generally tilts to favor capital. What he does give us is a way to analyze law by demonstrating the effect – positive, negative, or neutral – law has on economic inequality. Piketty proposed new, macroeconomic approaches to be developed in a revived data-driven study of political economy. Hus takes us a step further by showing that, in the study of law an important but generally missing element, is the need to study the impact law has on economic inequality.