Advance Praise for Elite Networks

“Vuković’s sweeping reimagining of the drivers of economic inequality introduces the notion of elite
networks—informal social networks between political and economic leaders—as a key mechanism
behind the steady accumulation of wealth by small elites in almost all societies. Moving beyond
explanation, he identifies concrete steps to advance economic equality through decentralizing reforms. A
powerful, compelling combination of theory, history, and data analysis that should reshape how we
understand the links between economic and political power.”
—Jacob N. Shapiro, Princeton University

“Elite Networks is a powerful and groundbreaking analysis of how privileged groups exploit their
positions to secure economic resources. In this wide-ranging tour de force, Vuković shows how
political influence pervades every aspect of our economy, underpinning the global rise in inequality.”
—Ben Ansell, University of Oxford, and author of Why Politics Fails

“This is a supremely ambitious and provocative book. It offers a sweeping account of the sources of
inequality across the world and attempts to uncover and document universal laws about capitalism,
social and political organization, and the distribution of resources akin to Thomas Pikketty’s Capital in
the 21st Century. Deemphasizing the idea that market power or enduring competitive advantages are a
symptom of the search for profits in the crucible of creative destruction, Vuković stresses that, even in
the most innovative countries, corporations secure barriers to entry that engender entrenched class
stratification. It therefore follows that sealed off elite networks are at the heart of modern, post
Malthusian inequality everywhere, both in the developed and developing world. Whether you agree or
not, this is a must read!”
—Victor Menaldo, Professor, University of Washington, and Co-founder of the UW Political Economy
Forum

“Elite Networks is a groundbreaking book that delves deep into the roots of income inequality.
Empirically and descriptively rich, the book elucidates how extractive political power drives this
pervasive problem, unveiling the intricate web of informal relationships between politicians and
influential corporate figures. The book's strength lies in its ability to connect the dots between intra-elite
trust, loyalty, and the alarming income disparities we witness today. What sets the book apart is its bold
assertion that income inequality is not an inherent feature of economic systems but a result of deliberate
actions stemming from the quest for centralized political power. In a world grappling with inequality, this
book challenges us to rethink our approach and offers a path toward a fairer society. Elite Networks is
a must-read for anyone seeking a deeper understanding of income inequality and a roadmap for
meaningful change.”
—Josip Glaurdic, University of Luxembourg
 Elite Networks
The Political Economy of Inequality
VUK VUKOVIĆ
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Library of Congress Cataloging-in-Publication Data
Names: Vuković, Vuk, 1988– author.
Title: Elite networks / Vuk Vuković.
Description: New York, NY : Oxford University Press, [2024] |
Includes bibliographical references and index.
Identifiers: LCCN 2023056791 (print) | LCCN 2023056792 (ebook) |
ISBN 9780197774236 (paperback) | ISBN 9780197774229 (hardback) |
ISBN 9780197774250 (epub)
Subjects: LCSH: Strategic alliances (Business)—Political aspects. |
Elite (Social sciences)—Economic aspects. | Business and politics. |
Income distribution—Political aspects.
Classification: LCC HD69. S8 V85 2024 (print) | LCC HD69. S8 (ebook) |
DDC 322/.3—dc23/eng/20240221
LC record available at https://lccn.loc.gov/2023056791
LC ebook record available at https://lccn.loc.gov/2023056792
DOI: 10.1093/oso/9780197774229.001.0001
To my loved ones, Barbara, Nikola, Josip, and Ema
 Contents

Preface
Acknowledgments

Introduction: Connecting Elite Power to Inequality

I.1. Main Contributions
I.2. Why Join Elite Networks? The Three Principles
I.3. Why Should Elite Networks Have Any Effect on Inequality?
I.4. The Cyclicality of Inequality
I.5. What This Book Does Not Do: External Validity Limitations and
Potential Extensions
I.6. Structure of the Book
1. Why Study Elite Networks?
1.1. Defining Elite Networks: Informal Mutually Beneficial Interactio
ns between Political and Corporate Elites
1.1.1. Does It Pay Off to Be Part of the Network?
1.1.2. The Role of Institutions
1.1.3. Elite Theory in Sociology
1.1.4. The Spontaneous Nature of Elite Networks
1.2. Visualizing Elite Networks
1.3. Putting Elite Networks on the Map of Political Interactions
1.4. Quantifying Elite Network Outcomes

PART I: THE IMPACT OF ELITE NETWORKS ON INEQUALITY

2. Evolution of Elite Networks and Inequality: Inequality in the Very
Long Run
2.1. The Agricultural Revolution: From Hunter-Gatherers to Settlers
2.2. How Exactly Did Farming Translate to Inequality?
2.3. Proto-States and the Formation of Hierarchical Orders
 2.4. Concentration of Wealth in Ancient Civilizations: Rise of the Malt
husian Economic Model
2.5. The Long Malthusian Trap: Inequality and Elite Concentration dur
ing the Middle Ages until the Industrial Revolution
2.6. Wealth Concentration and Elite Power in the 19th and 20th Centur
ies: From a “Society of Rentiers” to a “Society of Managers”
3. Democracy and Inequality in the Short Run
3.1. The Switch toward Democracy
3.2. The Relationship between Democracy and Inequality
3.3. The Rise of Government Spending in Democracies
3.4. The Rise of Inequality in Democracies
3.5. Economic Explanations of the Rise of Inequality
3.6. Political Factors That Could Help Explain the Rise of Inequality
4. Political Networks and Wages of Top Corporate Income Earners
4.1. Data and Variables
4.1.1. Measuring Networks and Connections of Individuals and
Firms
4.1.2. Correlation between Political Connections and Network
Size
4.2. Inequality in Top Executive Incomes
4.3. Empirical Strategy and Results
4.3.1. Results: United States
4.3.2. Results: United Kingdom
4.4. The Impact of Political Connections on Executive Salaries in Oth
er Countries

PART II: INSIDE THE LOGIC OF AN ELITE NETWORK

5. The Internal Logic of an Elite Network
5.1. Network Theory of Elites
5.1.1. The Link between Clustering and Size of Networks
5.1.2. The Centrality of Elite Network Superhubs
5.1.3. Historical Examples of Elite Networks
5.1.4. Incentives for Firms and the Impact on Inequality
5.2. Economic Theory: Costs and Benefits of Elite Network Members
hip
 5.3. Joining Elite Networks to Mitigate Risk and Achieve Status: The
Three Principles
6. Motivation for Politicians: Extracting Rents and Staying in Power
6.1. Corruption, Clientelism, and Rent-Extraction
6.1.1. Political Agency
6.2. Do Voters Punish Corruption?
6.3. Elite Networks and the Selectorate Theory
6.3.1. The Nonlinearity between Corruption and Political Survi
val
6.4. Case Study: Using Corruption and Minimum Winning Coalitions t
o Stay in Power
6.4.1. The Impact of Minimum Winning Coalitions
7. The Role of the Firm
7.1. Rent-Seeking vs. Customer-Seeking Firms
7.2. How Firms Benefit from Collusion with Politics
7.3. The Revolving Door between Politics and Finance
7.4. Case Study: Political Allocation of TARP Funds during 2008 and
2009

PART III: REDUCING POLITICAL POWER, THE ROOT CAUSE OF INE

QUALITY
8. Capitalism and Democracy
8.1. How Far Have We Come?
8.2. Persistent Incentive to Change
8.3. The Gradual Shift to Democracy
8.4. Democracies as a Trial-and-Error Process
8.5. Socialism’s Rapid Industrialization with a Lack of Trial-and-Erro
r in the Underdeveloped Periphery
8.5.1. Condensing 200 Years of Gradual Progress into 30 Years
of Rapid Growth
9. The Pitfalls of Political Power: Expanding the Scope of Governmen
t to Reduce Inequality
9.1. Progressive Taxation
9.1.1. The Unprecedented 30-Year Period That Brought Down I
nequality
 9.1.2. The Artificial Decrease of Inequality
9.2. Adverse Selection into Politics
9.2.1. Personalization of Governing Institutions
9.3. The Importance of Trust
10. The Three Levers
10.1. Moving beyond Standard Approaches: Introducing the Three Leve
rs
10.2. First Lever: Reducing Political Power
10.2.1. Full Transparency of Budgetary Spending and Decision-
Making
10.2.2. Encourage and Promote Free, Independent Media
10.2.3. Term Limits and Strict Conditions for Holding Office
10.2.4. Reduce Discretionary Decision-Making Power and Intro
duce Rule-Based Politics
10.2.5. Reduce the Scope of Centralized Government
10.2.6. Minor Reforms That Could Strengthen the First Lever
10.3. Second Lever: Re-Empowering the Citizens
10.3.1. Give Citizens the Ability to Take Control of Their Tax Pa
yments
10.3.2. Mandatory Participatory Budgeting for Community Public
Good Provision
10.3.3. Granting Impeachment Powers to the Citizens for Direct
Punishment of Officials
10.4. Third Lever: Re-Empowering the Community
10.4.1. Decentralize and Depersonalize Decision-Making over A
llocation of Public Funds
10.5. Second- and Third-Order Effects of the Three Levers

Afterword
Notes
References
Index
 Preface

This is a book about political power and inequality. It shows how the
collusion between political and corporate power affects the distribution of
incomes. Its most important goal is to offer a novel perspective on the long-
run origins of inequality by introducing the concept of elite networks and
examining their effects on the distribution of power and incomes.
Inequality is a man-made, yet persistent condition of human history ever
since the Agricultural Revolution. It is by no means a modern phenomenon,
nor is it linked to one economic system. It has been present, to a varying
level of intensity, during prehistoric times, in ancient civilizations, during
feudalism, and in modern times in both capitalist and socialist economic
systems. In premodern, Malthusian, societies poverty was a widespread
constant. Living standards for the vast majority of the population were
abysmal, while a small ruling class owned 90% of all societal wealth. In
order to achieve above-subsistence income during those times people could
either engage in wars, generating wealth via violent extraction, or by being
lucky enough to be born into the ruling class, which typically gained its status
through violence at some point in their history. Inequality was high, but it
also fluctuated and typically decreased only as a consequence of adverse
events like wars, pandemics, or societal upheavals.
In modern societies, particularly since the mid-20th century, we are
witnessing a decline of poverty and an unprecedent increase in living
standards for the first time in human history. Inequality, however, still
persists given that forces determining inequality are different from forces that
used to keep populations stranded in poverty and dismal living standards.
The argument presented in this book is that there exists a constant force
among humans, an incentive rooted deeply within our behavioral patterns,
that is responsible for persistently pushing inequality up. This does not imply
that we have to justify it or endure it. Quite the contrary. But in order to solve
it, we first need to understand its root causes.
 Which brings us to the second goal of the book: defining elite networks.
Elite networks are informal social networks between politicians in power
and top corporate executives or owners of politically connected firms where
personal ties and long-term interactions build trust and loyalty between
involved actors. Both groups draw benefits from these interactions.
Politicians stay in power and may extract bribes and other favors, while
firms are rewarded with exclusive government contracts, favorable
regulation, or direct subsidies. Top corporate executives successfully
acquire rents for their firms as a result of their elite network interactions, and
are rewarded by their firms with higher salaries. This consequentially
widens the dispersion of earnings between the top 1% or top 0.1% of income
earners (most of whom are corporate executives) and everyone else.
This is what we observe in the modern era, where elite networks exist
through interactions between corporate executives, owners of capital, and
politicians. In premodern times their structure was different—a network
formed between the nobility, clergy, and the rulers—but their effect on
society was the same. Throughout human history an incentive to join elite
networks has been driven by the same reason, a force I define as the violence
power principle.
The use of violence based on holding power motivated human behavior
for ages and served as a perpetual justification for wealth extraction and
entrenched inequality. Wealth and opportunities were constrained only to
those with access or proximity to power—the early ruling elites, which had
the monopoly over the use of violence and coercion. Religion served an
important role as well. Rulers used religion to grant themselves divine rights
to govern, thus ensuring the loyalty of their subordinates. No one questions
the divine legitimacy of a ruler, especially when the ruler upholds that
ideological advantage through a network of preachers. The early elites thus
had every incentive to preserve their position and make it permanent and
hereditary. Only a descendent of nobility can claim divine right to a throne.
Political and social institutions were designed as hierarchical orders with a
goal to strengthen the elites’ legitimacy over the hold of power and use of
violence. The army became a necessary institution to preserve that
legitimacy. It was the dominant political-economic system for centuries, even
millennia, and it is the legacy of every country today. For thousands of years,
wealth was condensed in the hands of a small elite with legitimacy to use
violence in their quest for power.
 With the rise of Enlightenment and subsequently the Industrial Revolution,
the emphasis on individual freedom started gradually overtaking the
dominant coercion narrative. However, one does not simply erase the long
shadow of history in how these hierarchical orders were established and
what their effect was. The elites always had strong instincts for self-
preservation, so much so that even during revolutionary times, the majority of
elite networks kept their fortunes and positions in the social hierarchy. They
managed to permanently preserve the violence power mechanism, in some
countries dominantly, in others latently. Only recently have our societies
learned how to become more inclusive, giving impetus for the voluntary
exchange principle—coercion-free exchange that delivers the greatest
benefit to all involved parties, protected by inclusive political institutions
delivering the necessary public goods. However, despite the enormous
progress our societies have made because of the voluntary exchange
mechanism, it is difficult to overcome a principle that has guided human
behavior for such a long time.
The violence power principle implies concentrating political and
economic power in hierarchical governing institutions with little sense of
accountability. This is true for governments and corporations, both of which
seek to eliminate competing powers. Corporations today, similar to nobility
in the past, seek protection of their interests via proximity to political power.
This is what drives modern-day inequality and is guided by rent-extraction in
the form of misuse and usurpation of political power. Obviously not all
corporations exist under the realms of political power, but those that do are
the drivers of income inequality in the same fashion as in the early days of
capitalism or in premodern times: lowering risk-exposure via seeking
political protection through forming elite networks.
Big Tech firms are a good example here. They achieved market
dominance based on their proprietary innovations and the network externality
effects arising from those innovations. However, today, when voters and
policymakers want to limit their power by changing the regulatory framework
—such as limiting the use of private data or the scope of algorithms that
anticipate our behavior better than ourselves—the response from the tech
industry is to infiltrate into elite networks. They hire former in-office
politicians to serve as de facto lobbyists, thus exploiting their deep network
of connections to their benefit. This can be fully legitimate, but it is exactly
the type of behavior that firms use to protect their status. The consequence is
a growing dispersion of income driven by between-firm differences.
Whenever an innovator turns into a rent-seeker, their high relative incomes
are no longer purely a result of innovation or productivity growth.
Joining elite networks is therefore a trade-off between coercion-free
earnings on the market, and coercion-driven earnings generated through
proximity to power. The violence power principle explains the main
motivation of elite network formation and how it is used to perpetuate
economic inequality.
Inequality, however, has also been cyclical, subject to ups and downs,
which might seem contradictory to the argument just presented. If the origin
of inequality is rooted in the quest for political power, which is a persistent
incentive in any society, then we should always observe a consistently high
level of inequality across every society. Inequality is subject to two
additional forces that determine its long-run cyclicality: one that pushes
inequality up constantly, and the other that lowers it occasionally. I call the
first a force of wealth concentration, and the second a force of occasional
destruction.
The force of occasional destruction consists of four types of events that
have been recognized as powerful levelers of inequality throughout history:
wars, plagues, state failures, and revolutions. In the 20th century, when
inequality declined faster than ever before, it did so because societies
underwent 30 unprecedented years in the first half of the 20th century that
included two major wars, a postwar pandemic, a major economic
depression, and hyperinflation. All reforms enacted after these events were
designed to prevent such outcomes from occurring ever again, and societies
finally flourished. Therefore, only powerful, unpredictable events can
seriously undermine inequality—both directly, and through policy solutions
in its aftermath—simply because they tend to undermine the existing order
and lead to a dissolution of existing elite networks.
Over time, the elites adapt, meaning that inequality eventually resurfaces.
This is driven by the forces of wealth concentration, where uninterrupted
periods of economic progress often lead to misuse of political power to once
again concentrate wealth within the elites. In preindustrial times this was
obvious given that economic development itself was contingent on political
power. Wealth was expropriated by the ruling elites. During the early stages
of the Industrial Revolution inequality was even higher due to privileges
granted by proximity to political power. In modern societies, the role of
political power has been subdued and progress is no longer driven purely by
the ruling elites, but rent-seeking corporations still benefit from its proximity,
further building momentum for inequality.
The goal of this book is to show how long-run forces behind inequality
were always rooted in centralized and extractive political power.
Centralization of power enables the network effect that creates elite
networks, which enable rent-seeking opportunities to its members,
consequentially increasing inequality. Inequality is not an artifact of a
particular economic system, it is not a modern nor a natural phenomenon, but
a man-made phenomenon rooted deeply within the, often violent, quest for
political power.
Having redefined the sources of inequality, we also need a redefinition of
its solutions. Inequality cannot be lowered or curbed by giving more power
to politicians and regulators to deliver just outcomes. Greater centralized
political power only increases incentives for elite network formation.
Progressive taxation on the other hand, is merely dealing with the
consequences instead of the true causes of inequality. A top executive will
benefit from proximity to political power regardless of their top marginal tax
rate. An owner of a firm with political protection avoids any punishment for
regulatory noncompliance. If we wish to truly lower inequality and prevent
incentives of elite network formation we must first and foremost lower
centralized political power and re-empower the citizens and the community,
and we must do so by rebuilding trust and relying on the democratic trial-
and-error mechanism. The final goal of the book is to deliver at least some
answers as to how we can achieve this.
 Acknowledgments

Like every book, mine too was a product of a joint effort containing many
revisions, different versions, helpful comments, and useful additions,
however with me holding full accountability over all errors and omissions.
The origin of the book was my Oxford DPhil thesis, written as a three-paper
dissertation from 2016 to 2019 under the supervision of my extraordinary
mentor Professor Ben Ansell, to whom I own considerable gratitude. Not
only for his academic prowess but also for his genuine guidance as a mentor
during the DPhil and later in my career. His invaluable advice, comments,
criticisms, and many suggestions helped make the thesis, and later the book,
into what it is today. Of the three papers, two were published and their
results are summarized and presented in the book (in Chapters 6 and 7),
while the third paper has been adapted into the crucial empirical chapter of
the book (Chapter 4). The rest of it has been completed in the years after my
time at Oxford. Therefore, the empirical findings developed within the thesis
represent the cornerstone argument of the book, but everything else, the entire
theoretical and historical background developed to support the findings, was
written later. In this process I had great support from my editor at Oxford
University Press, James Cook, two excellent reviewers who greatly
improved the quality of the arguments, and the entire OUP editorial team that
handled my book. To all of them I also express genuine gratitude.
During my time at Oxford, I benefited from conversations and comments
on my work from a number of individuals, all of whom I owe a special thank
you: Andrew Eggers, Elias Dinas, Robin Hardin, Jacob Nyrup, Josip
Glaurdić, Valentino Larcinese, the late Alan Krueger, Joshua Angrist, Jacob
N. Shapiro, Dejan Kovač, Boris Podobnik, Vedrana Pribičević, Jurica Zrnc,
and Victor Menaldo. I would also like to extend a thank you to the
participants at various conferences where I presented the empirical findings
of my papers, which are crucial parts of the book: the 2017 and 2018
American Political Science Association Annual Meetings in San Francisco
and Boston, the 2018 PIIRS Conference at Princeton University, the 2017
Nuffield Politics Graduate Student Conference at Oxford, etc. The findings
on corruption and local government in Croatia (presented in Chapter 6) have
been presented at the Croatian Parliament, in front of the National Council
for Monitoring the Anti-Corruption Strategy in November 2017. I thank the
members of the Council for expressing interest in the research that came as a
result of this thesis.
For data extraction, I would like to thank Mile Šikić and Marko Rakar for
extracting parts of the original procurement database I used, and to Dejan
Vinković for helping me assemble the network datasets. I would also like to
thank my research assistants from Oraclum, Luči Krnić and Sanja Deur, for
help on drawing all the network graphs used in Chapter 1. I am thankful to the
Center for Responsive Politics for providing the data on lobbying and
campaign contributions, and to the Wharton Research Data Service (WRDS)
for access to the BoardEx database on individual-level corporate and
political connections.
During my research phase for the thesis, I held numerous interviews with
individuals involved in tracking corruption in the public procurement
process in Croatia, as well as individuals involved in oversight or decision-
making regarding the allocation of TARP funds in the United States, all of
whom wished to remain anonymous. A special thank you goes to Damon
Silver from the TARP Oversight Subcommittee for providing important
guidelines over the TARP distribution process. I am indebted to all of these
individuals and institutions for their valuable and indispensable help in
various parts of the thesis.
While doing my DPhil research at Oxford, I was a member of Pembroke
College, from which I received incredible support, both academic and
financial. Pembroke provided me with an academic scholarship and gave me
a travel grant for every single conference I wanted to attend and present my
results. In addition to my college, I also received numerous outside
scholarships: the Sir Richard Stapley Educational Trust grant, the IHS
fellowship, the Koch Foundation dissertation grant (awarded to me by my
later associate, Scott Alford), the John Blundell Scholarship from the Adam
Smith Institute, in addition to numerous other grants. A special thank you to
that end goes to Jessica and Peter Frankopan for the Frankopan Fund
Scholarship I have received each year while at Oxford. Every single one of
these scholarships were of immense importance to me, and I am thankful to
everyone who supported my research.
The one person, however, who has made the greatest effort in diligently
reading all my work during my entire academic career was my father, Nikola.
I am forever indebted to him for his continuous intellectual support, his
immense personal library that was at my disposal since I was a child, and the
numerous long conversations we still have about economics, politics, and
history.
Finally, the book would be impossible without the ongoing love and
support from my wife, Barbara, and our three kids, Nikola, Josip, and Ema.
To them I dedicate my work.
 Introduction
Connecting Elite Power to Inequality

Citizens of “developed” nations find the expropriative antics of foreign despots exotic,
sometimes even laughable. But the shakedowns practiced by their own politicians are different
only in the complexity, camouflage, and rhetoric surrounding the expropriation threats and
ultimate extraction schemes.
—Fred S. McChesney (1997) Money for Nothing, p. 68

Can you buy a Big Mac in Tunisia? Back in 2008 McDonald’s tried to award
their franchise to a local company to open a restaurant in the capital city. It
was the “wrong” company. The government of the all-powerful President
Zine El Abidine Ben Ali stopped the deal, citing disagreements over the
purchases of domestic Tunisian-made meat in order to ensure that the meat
was Halal. McDonald’s operates in many Muslim countries and certainly
does produce meat that is Halal, even when it is not locally bought. The
problem was that by doing so the franchise would avoid signing a big
contract with the local meat company under direct protection of the president.
According to a classified report1 from the American Embassy in Tunisia
from 2008, “Corruption in Tunisia: What’s Yours Is Mine,” the real reason
was obvious:
there are still several examples of foreign companies or investors being pressured into joining with
the “right” partner. The prime example remains McDonald’s failed entry into Tunisia. When
McDonald’s chose to limit Tunisia to one franchisee not of the GOT’s [Government of Tunisia’s]
choosing, the whole deal was scuttled by the GOT’s refusal to grant the necessary authorization
and McDonald’s unwillingness to play the game by granting a license to a franchisee with Family
connections.

This is a typical story surrounding Ben Ali’s 24-year reign over Tunisia. The
reign started in 1987 and ended abruptly in 2011 after mass protests that
successfully overthrew him and later sentenced him to life imprisonment—
however in absentia, as he fled the country—on charges of theft, money
laundering, violence, and murder. After he was ousted, his personal wealth
was estimated to around $13bn, about a quarter of the country’s GDP.
According to a 2014 World Bank working paper2 that reconstructed the story
behind Ben Ali’s fortune, by the time he was ousted he and his family had
ownership in almost 220 firms, which were responsible for 3.2% of the
country’s output and 21.3% of its profits in 2010. These were the “right”
companies to do business with in Tunisia.
Ben Ali had a simple strategy. He manipulated the country’s investment
laws to enact entry barriers for any competition and thus enabled his
companies to charge monopoly prices. His family was present in all the
major industries: telecoms, banking, transport, distribution, real estate,
hotels, restaurants; altogether he restricted access in 45 different sectors
where his interest was present. What were the consequences of such
restricted competition and monopoly pricing on Tunisia’s population?
Primarily, higher prices of goods and services (telephone prices on
international calls, for example, were 20 times higher than the market price).
More importantly, there were lack of employment opportunities to anyone not
connected to the family’s clan, not to mention failures of many entrepreneurs
or investors who were not connected to the government. Higher levels of
income and wealth inequality were a natural consequence. The connected
few in the political and corporate world benefited at the expense of the
unconnected majority. The situation has not improved much in the decade
after Ben Ali’s departure. Well-connected firms still profit from privileged
access to government. The dictator is gone, but the crony system remains.
What does collusion between politicians and corporate executives look
like? It looks exactly like Ben Ali’s Tunisia. It looks like the Siemens
scandal of bribing public officials across the world to get lucrative projects,
thus earning a hefty profit for both the company and its chief executives. It
looks like the 1MDB scandal in Malaysia, a development fund set up by a
businessman-turned-fugitive, Jho Low, who, using an elaborate scheme and a
huge personal power network spanning from Middle Eastern royal families
to Hollywood to Goldman Sachs, funneled billions of dollars both to himself
and the then-prime minister Najib Razak. Goldman’s executives earned
$600m in fees, but their former Southeast Asia chairman Tim Leissner faced
embezzlement charges, while Goldman is seeking a settlement with the US
Justice Department. It looks like the Gürtel corruption scandal in Spain
involving a businessman, Francisco Correa, who was funneling money to
ruling party politicians in exchange for exclusive procurement contracts. It
looks like the infamous Tangetopoli affair in Italy in the 1990s, uncovered by
a special investigation “Manu pulite” (clean hands) that led to indictments of
over half the Italian parliament and local government, effectively destroying
the dominant Christian Democracy party in 1994.3 The system was so corrupt
that a bribe or a “kickback” (tangente) was considered a standard
commitment every firm who wanted to do a job with the government had to
pay. Italy had its elite network institutionalized.
It looks exactly like what was uncovered during “Operation Car Wash”
(Lava Jato) in Brazil in 2014.4 One of the biggest “corruption machines”
ever built involved 20 multinational corporations and a whopping $800
million paid in bribes. At the center of it was a Brazilian construction
conglomerate Odebrecht, whose senior executives engineered massive frauds
across Latin America and beyond. They were signing large construction
contracts (building airports, power plants, dams, refineries) and were
extracting money by creating shell firms with secret bank accounts to pay for
fake invoices from fake customers. To cover it all up they heavily bribed
whichever government official they needed, from local mayors to presidents.
Their bribes helped fund political campaigns of several presidents across the
continent, and pay off hundreds of legislators in each country where they did
business. Needless to say, they built their own elite network, as efficient and
lucrative as the one built by Ben Ali in Tunisia, and as institutionalized as the
one in Italy. Lava Jato exposed the extent of Brazil’s (and Latin America’s)
deeply corrupt system in which politics and business virtually hijacked the
country’s economic growth and kept inequality among the highest in the
world.
Ben Ali’s Tunisia is a case in point of when a ruling politician captures
the state and uses it for personal enrichment of himself, his family, his close
cronies, and all the firms connected to them. Suharto’s Indonesia, Fujimori’s
Peru, or Putin’s Russia are almost identical examples, to mention only a few.
Sometimes the pull factor comes directly from politicians (like in Italy,
Tunisia, or Russia), sometimes from corporate executives (as with
Odebrecht, Siemens, or 1MDB), but in each case their collusion reaps
negative effects for the vast majority of the population. Heavily protected
cartels and monopolies raise prices thus lowering disposable incomes and
living standards. The political and corporate collusion restricts climbing the
social ladder only to those connected with the elites. In the extreme cases,
because huge parts of public budgets get expropriated for rent-extraction, it
reduces the supply of necessary public goods like health care, education, or
basic infrastructure (sewage, water, electricity), leaving major parts of the
population stranded in abject poverty.
As exemplified by McChesney’s quote from the beginning of this chapter,
there is not much of a difference—in the logic of obtaining and consolidating
power—between a despotic ruler in a kleptocracy and the connections he has
with local corporations and local cronies, and an elected official in an
institutionally stable democracy and the connections he has with a plethora of
powerful interest groups. Almost all despotic leaders in history have one
thing in common: creating a powerful coalition with the nation’s elites that
helped them preserve their position of power, very often at the expense of the
people who were condemned to poverty and dismal living standards.
Whether these were the nobles during the ages of medieval kings, the
conquistadors, and other mercantilist colonial elites during the Age of
Discovery, the military juntas in postcolonial kleptocracies, the oligarchs in
postcommunist kleptocracies, or even the modern corporate elites that
finance political campaigns in exchange for preferential treatment—in each
case the collusion between business or military power with political power
generated negative socioeconomic effects on the rest of the population.
Modern democracies are hardly comparable even to their historical
antecedents let alone monarchies or present-day autocracies, but their elites
are guided by similar principals. Particularly when the positions of power
are subject to less scrutiny and lower accountability.
Consider another set of examples limited to the United States, the beacon
of democracy and a role model of a well-defined constitutional order. During
the second half of the 19th century New York politics was dominated by the
infamous Democratic Party political machine Tammany Hall. This group of
politicians did not just collude with business interests—they merged politics
and business into one, benefiting vastly from their accumulated position of
political power. Tammany Hall was an organization notorious for its
patronage systems and outright corruption. It built a massive organization of
loyal supporters, making sure that its members were well-placed within the
system to obtain full control. Their actions included everything from direct
bribery, extortion, budgetary misappropriation, vote-buying, nepotism, even
directly buying judges and thwarting any sign of reform of its deeply corrupt
system of governance.5
 The most famous leader of this organization was William “Boss” Tweed.
Although he was only a mere member of the New York State Senate, his
tenure as Tammany boss landed him immense political power, giving him
direct control over the New York job market, as well as the voting process
itself. Tweed was a large landowner in the city, director of a railroad
company, a bank, a printing company, and a hotel. The law did catch up to
him eventually. In 1877 he was convicted for stealing between $25 million
and $45 million (which in today’s inflation-adjusted terms would be over $1
billion6). Other notorious examples of Tammany Hall political-made
millionaires were John Kelly and his successor Richard Croker, who were
running the machine like a “well-oiled criminal organization,” or the case of
George W. Plunkitt, who admittedly bought land he knew the city was
planning to buy, and sold it back to the city for an inflated price. It was, in his
own words, “honest graft.”7 There is hardly any difference between the
modus operandi of Tammany bosses and any robber baron of the Gilded Age.
Or Ben Ali in modern-day Tunisia.
Political corruption and collusion between politics and business did not
end with the Gilded Age in America. It evolved. Consider the recent case of
Robert Rizzo, a city manager of the small town Bell in California.8 Rizzo
was in power for 17 years in this poor, mainly Hispanic community with a
population of slightly over 35,000 people. During this time, he managed to
consistently misappropriate public resources for his own benefit and for the
benefit of his small group of business and political cronies. He paid himself
an annual salary of $787,637, almost twice as high as that of the US
president, and four times as much as the state’s governor. The law caught up
with him in 2014 and sentenced him to 12 years in prison on various
corruption charges.9 A similar case of political bribery and misuse of power
to benefit a small group of people close to him was that of former Illinois
governor Rod Blagojevich, who ended up with a 14-year prison sentence.
His fellow party member and longest-serving Chicago mayor Richard Daley
avoided prison, but his reign was marred with significant controversies of
allocating city contracting jobs to personal friends and political allies.
National-level politics in the United States is certainly not immune to
collusion. However, the monetary amounts uncovered by investigations are
quite modest compared to even US local politics, let alone their foreign
counterparts. The House, for example, faced two big corruption scandals in
the 1990s, the House banking scandal and the Congressional Post Office
scandal, both of which led to embezzlement, bribery, and money laundering
charges against several Congressmen. Around the same time DC politics was
dominated by a powerful lobbyist Jack Abramoff, dubbed the “Man Who
Bought Washington.”10 Abramoff was the embodiment of a powerful network
of interest, a true superhub, the key person connecting business and politics.
He bribed Congressmen with money, golf courses, tickets to events, and
expensive meals to get whatever was necessary for his clients. House
Majority Leader Tom DeLay was one of the victims of Abramoff’s web of
deceit, indicted over alleged money laundering. These cases are not few and
far between. They are massive and reoccurring.
Very often, however, political capture in the United States is not driven by
politicians, but by the corporate world. Connections between Wall Street
executives and office-holding politicians (presented in greater detail in Chap
ter 7), or between politicians and the tech community are much more subtle
today than they were during the Gilded Age, but that does not make them any
less benign than a relationship between a corrupt mayor and his cronies, or
between a kleptocratic ruler and his oligarchs in any postcommunist society.
If anything, the money involved is greater and their consequences much
worse. Consider the frauds involving Elizabeth Holmes’s Theranos in 2016
or Sam Bankman-Fried’s FTX in 2022. Each is a case in point of how
unicorn start-ups, offering fanciful technological solutions to big issues, used
political connections to boost their companies’ valuations, only to create an
exuberant self-defeating spiral that ended up hurting their investors and
defrauding their customers. The meteoritic rise of both companies was made
possible primarily due to their access and infiltration into the biggest elite
networks in corporate and political America. Holmes filled her board with
top-tier former politicians, including two former secretaries of state, George
Shultz and Henry Kissinger, in addition to other former senators, generals,
and cabinet members. It was the connection with Shultz in particular that
convinced a host of other former politicians and corporate executives from
his network to join in and support the company. Bankman-Fried went even
further, becoming one of the biggest donors to the Democratic Party, using his
parents’ political connections to navigate the venture capital investor field
very quickly and successfully, while building a fraudulent product that lost
billions for its customers. In these cases, politicians were among the many
victims of the fraudsters, but they trusted them simply because they were part
of the same elite network.
 Another good example of (mis)using elite network status to commit fraud
was Bernie Madoff’s four-decade long fraud. Unlike Holmes and Bankman-
Fried who most likely did not initiate their ventures with an idea of
committing fraud, and later became victims of their own fake-it-till-you-
make-it mindset, Madoff’s business was a pyramid scheme by design
practically from the onset. And yet, even when his fraud was becoming
obvious and exposed in the media, he repeatedly used his influence to avoid
prosecution for years. On several occasions he used his ties to the SEC to
prevent ongoing investigations. He didn’t lobby or bribe anyone, nor was
there any direct quid pro quo involved. He called the chairperson of the
SEC, his friend, and politely questioned why they were even investigating
him, which ended the investigation. For members of elite networks there is
no need to buy influence. Personal relationships are more than enough to
sway decisions. Eventually he was brought down, not by the SEC, but by the
financial crisis of 2008, as more and more of his clients wanted to withdraw
their money due to nationwide financial difficulties, and the pyramid scheme
was fully exposed.
The examples mentioned thus far were all, conveniently, fraudsters and
criminals using political influence for personal enrichment. However, there
are many more examples of nonfraudsters who use political connections to
advance their interests—the highly connected corporate CEOs, board
members, and owners of politically connected firms which are the focus of
this book. The vast majority of them are not engaged in any illicit or even
unethical activity. They become illegal when fraud is the object, but much
more often than not, none of these people are committing fraud. They are
merely advancing their interests, and this causes unintended social
consequences. Needless to say, for all those who use political protection to
advance their interest, there are many more who do not and who succeed
based on value added and innovation. These individuals and their firms are
not the issue. The issue is a systemic fault of allowing certain elite networks
to capture political power.
Traditionally robust US institutions are failing to prevent such outcomes
because they get captured by elite networks, who have little constraint in
bending the rules to their will. The law does react, but only ex post, after a
serious fraud has already been exposed (as with Madoff or Enron). It is
becoming increasingly difficult to prevent political capture from elite
networks ex ante. Fukuyama’s seminal contribution on US political decay
presents a detailed historical overview of how strong US institutions,
developed in the aftermath of the Gilded Age and as a direct response to
cronyism of robber barons and political machines like Tammany Hall, started
to subside and decay precisely because of interest group state capture and
lack of institutional adaptation in the late 20th century.11 Lobbying activities,
super PACs, or the revolving door practice of former staffers working for
industry giants are all completely legal and even fully legitimate ways for
various individuals and organized groups to pursue their interest. In this
pursuit some groups will fare better than others. According to Olson, because
of their inability to solve the collective action problem, the latent
(unorganized, dispersed) groups will lose out at the expense of the privileged
(organized, narrow) ones, thus skewing the distribution of resources toward
groups with more power and with a more narrowly defined set of interests.12
The question is does the pursuit of one’s interests hamper market outcomes,
benefiting the few at the expense of the many?
The aforementioned cases, and many others occurring across the globe—
from the least developed, institutionally deficient countries with very low
democratic capital to the most developed, constitutionally well-defined
countries endowed with democratic capital—suggest that even rich and
advanced democracies are not immune to the logic of power and behavior of
elite networks.

I.1. Main Contributions

The main contribution of the book is to show how elite networks—informal
social networks between politicians and politically connected firms—
generate a negative effect on inequality. The inequality literature mostly
overlooks this very important mechanism of how the misuse of power
translates into inequality. The mechanism is rather simple, it has been with us
for centuries (with elected politicians and corporate executives replacing
kings and nobility), and mostly works in the following way: politicians and
senior corporate executives or owners of connected firms draw benefits from
continuous mutual interactions. Politicians are given campaign donations and
other forms of support which enable them to win elections and stay in office,
while firms are rewarded with government procurement contracts, favorable
regulation and legislation, monopoly rights over a certain good or service, or
direct subsidies in times of need. Top-level corporate executives responsible
for securing rents for their firms get rewarded with higher compensation.
This is where interactions of elite network members yield a direct negative
impact on the distribution of incomes. Senior corporate executives
(especially for publicly listed firms) are all in the top 1% and even top 0.1%
of income earners in a country. The inequality literature is consistent in
showing that the growth of incomes of the highest earners is the main cause of
rising inequality in contemporary Western democracies. The broader
implication of this book is that the high income inequality we observe today
could also have been influenced by political connections of top income
earners. In fact, the book shows that inequality typically is a result of
extractive political power, both today and historically. Individual-level
empirical findings presented in the book validate the many theoretical and
case-study arguments which suggest that usurpation of power by rent-
extracting executives carries a large weight in explaining the causes of
inequality.
The book does not aspire to become a theory of everything. Its long-run
historical analyses, theoretical explanations, and detailed empirical results
are necessary to justify the inclusion of political capture by elite networks as
one important and crucially overlooked factor of explaining inequality.
However, while contemplating the theory and empirical results presented in
the book, it is important not to neglect all the standard economic theories that
explain the rise and persistence of inequality, nor to neglect economic
theories that explain corporate success and failures based on competitive
advantages, differences in productivity, and adaptation of innovation.
Throughout the book I reference the vast and instructive inequality
literature13 according to which the leading cause of rising inequality
worldwide over the past four decades has been concentration of wealth and
incomes into a small minority of the population, the top 1% or 0.1% of
income earners. Globalization, technological progress generating creative
destruction, global competition for talent and skills, particularly among top-
tier corporate bosses leading to the emergence of superstars in the corporate
sphere (the “supermanagers”14), concentration of firm power, tax policy
reforms, and a number of other factors all have merit in explaining the rising
trends of the past decades. However, these theories, with a few exceptions,15
only explain the short-term trend, mostly of the 20th century, and do not
engage in providing a long-run theory of inequality persistence. Inequality
was present throughout recorded human history and across different political
systems and forms of governance, meaning that its origination has to have
deeper underlying root causes. In this book I link the persistence and
cyclicality of inequality to political power, examining how the misuse of
power by those with proximity to it presents a yet unexplored factor in
observing the inequality phenomenon.
The mechanism of elite network political capture does not, in any case,
suggest that success of firms is contingent on securing political support,
especially not in post–Industrial Revolution times. The way firms adapt
innovation and how they add value to their customers has been and always
will be the crucial determinant of their success. The majority of between-
firm differences will arise as a consequence of specific and enduring
competitive advantages. However, in that competitive race, some firms will
make a decision to secure privileges contingent on the personal relationship
their management has with key government officials. At a certain stage of the
firm’s life cycle, in order to preserve their status, some firms can and will
engage in political capture. Incumbents use political capture to influence
policies and prevent challengers from disrupting them. Obviously, this cannot
last forever. All incumbent firms that were large and powerful for a very
long time eventually succumbed to their challengers when time was ripe. But
this creative destruction process takes time, and before being completed it
renders economic inefficiencies as the market mechanism is prevented from
performing its optimal allocation process.
Industrial economic theory, theory of the firm, or other microeconomic
toolkits that are useful in understanding between-firm differences fail to
explain what happens when political power intervenes in the allocation
process. Firms thrive on attracting top human capital and securing a
technological edge in order to maintain their competitive advantage.
However, human capital and technology are nonuniformly distributed, and
they tend to flow to very specific geographical clusters. These same clusters
attract not only capital but also power, and it is in the intersection of money
and power where elite networks tend to form. The clustering is driven by
motives of securing competitive advantage and attracting human capital, but
its consequence is even greater concentration of wealth and power within a
small group of people. This is not done by some intelligent design, but as a
consequence of a network homophily effect that wants to optimize efficiency
and performance. Out of that network effect arises the spontaneous incentive
for greater assortativity up to a point where a network becomes highly
topocratic—it matters more who you know than what you know. At this phase
transition point a firm will cross the line from being a customer-seeker
(focusing on competing for customers in the marketplace via its competitive
advantage and innovative solutions) into a rent-seeker (competing in the
political arena for favors and privileges).
Historically, this phase transition was only possible after the Industrial
Revolution era. Industrialization brought new opportunities for small
innovators and merchants to generate above-subsistence wealth, as they
gradually, over more than a century, started to replace the landed aristocracy
and nobility. But at the same time, early capitalism was full of industrial
behemoths, led by individuals who could hardly have built their empires
without political support (from 19th-century US robber barons like
Rockefeller, Carnegie, Vanderbilt, Morgan, to Tammany Hall businessmen, to
the 18th-century British East India Company, etc.). Those who had initial
backing of political power made corporate conglomerates, others were
forced to compete on the marketplace, innovate, and grow through the value
added they offered to their customers. The transition from one type of firm to
another is still a latent motive present in firms when faced with declining
market share and nimble challengers. The self-preservation instinct is strong
and it will lead to elite network formation if necessary. Many firms,
particularly small and midsized ones, never get to that transition point, but
these firms are not where inequality originates. Inequality originates among
the top 0.1%, meaning that we must look at the structure of those within that
group to understand which factor, in addition to skills, talent, or luck, drives
their abnormal earnings, and ask, can this factor be attributed to market
forces alone, or is there a missing link?
⋆⋆⋆
Before we dive more deeply into the relationship between elite networks and
inequality, it is important to settle the definitions of a few concepts used
throughout the book. First and foremost, the definition and classification of
rents and the concept of rent-seeking.
Rents are typically defined as a source of income from exclusive
ownership of a limited resource, without adding any value or wealth to
society. Shiller uses a classic example of a feudal lord who places a chain
across a river on his land and then charges a fee to any boat that wants to
pass through.16 There is no value added to society, a cost is imposed to users
(for something that used to be free), and the only person to benefit is the lord
himself. This simple example illustrates that the opportunity to extract rents
must be given by some source of power and derived from ownership over a
limited resource. This is where the political process kicks in, as rents could
only be obtained if the rights to extract them were given to a market
participant by holders of political power.
The state can generate rents in a variety of ways. It can enact barriers to
entry for competitors through things like patents, intellectual property
protections, or licenses to specific occupations, it can directly grant
monopoly rights over a resource, it can artificially reduce supply via things
like tariffs to protect certain industries, it can give out subsidies, or it can
engage in illicit activities and corruption where a monetary concession is
exchanged for some form of privilege. Then there are modern rents, arising
from digital technology firms and their network externality effects. The
modern tech giants didn’t generate their market dominance by obtaining
political protection through barriers to entry or monopoly rights. They’ve
achieved it through their innovative products and demand-side economies of
scale where adaptability of a product depends on how many other people use
the same product. After becoming too big and realizing their dominance
through pure disruptive innovation, they are now seeking to preserve their
position through lobbying the regulatory process over the usage of personal
data and algorithms to target users. They are only now resorting to what the
political economy literature defines as classic rent-seeking—misusing the
political process to their benefit and preservation of status.
The usage of the concept of rents in this book is deliberately broad, but
also in line with how the political economy literature tends to examine rent
extraction. Rents are just one way of describing the outcome of what political
influence brings to an elite network member. They are an outcome of
misusing political power in order to generate a nonmarket source of income
or other nonmarket benefit. And it is through the misuse of power that rent-
seeking tends to occur. When top executives no longer focus on their
disruptive innovation but shift their activities to elite networking in order to
affect regulation and legislation, this is when they are rent-seeking: trying to
gain a privileged position on which they prove their value to their company.
Rent-seeking is a wealth-reducing activity that generates a host of negative
outcomes by impairing the allocative efficiency of the market mechanism. As
far as the literature is concerned, rents are by definition a by-product of
political capture. This is also how they are seen in the book; an outcome of
elite networking influence over political power. Rents don’t get translated
into inequality per se; the consequence of elite network interactions do.
The definition of inequality also comes with a clarification. In the book I
interchangeably use the concepts of “income” and “wealth” inequality, even
though the two are not the same nor do they necessarily have the same causes.
In the initial historical overview in Chapter 2, I focus the majority of my
attention on wealth inequality as the main source of inequality during the
preindustrial age, up until the 20th century. Income from capital—owning
land, means of production, or inheritance—was the key source of
differentiation in wealth. In the 20th century this changed; income from
capital lost its relative importance, and income from labor became the
crucial determinant of differences in personal wealth.17 Hence the necessity
to, at least in principle, equate wealth and income inequality; one was
important throughout human history until the 20th century, and is the subject
of the theoretical part of the book, while the other became important as of the
20th century, and is the subject of the empirical part of the book.

I.2. Why Join Elite Networks? The Three Principles

There is a deep, structural connection between elite power and the
consequences it projects on the distribution of incomes and wealth in a
society. In order to theoretically justify the origin of such a connection the
book must answer three basic questions: (1) why is there an incentive to join
an elite network?; (2) why should elite networks have any effect on
inequality, or better yet how do their actions translate into inequality?; and
(3) if there is a relationship, how does it explain the cyclical nature of
inequality? The following three subsections offer a brief answer to each of
these questions which are later tackled, theoretically and empirically,
throughout the book.
The first theoretical question concerns the motivation for elite
membership. Why do people have incentives to be connected to those in
power, and why do those in power need a crucial group of key supporters
around them? To answer this, we must first develop a theory of how people
mitigate risk, ensure their survival (how they realize the Lockean necessity
of subsisting18), and most importantly preserve their status. Within a society,
from ancient times until today, there are three basic principles of securing
one’s existence and status: (1) the voluntary market exchange principle, (2)
the principle of gift exchange, and (3) the violence power principle. Only
after understanding these three principles can we provide an answer as to
why people have incentives to form and join elite networks.
The voluntary market exchange principle is present when people satisfy
their needs by exchanging goods and services voluntarily without any
coercion, realized within a set of institutions whose rules all actors
consensually accept. These institutions can arise spontaneously (based on
social contracts or trust) or can be designed as public goods which offer a
number of institutional protections to engage in a transaction or relationship
with another individual: protecting basic human rights; ensuring equality
before the law and equality of opportunity; protecting and enabling free
exchange and entrepreneurship; protecting freedom of speech, freedom to
assemble, and freedom to promote ones interest; and protecting private
property. Societies have not been able to achieve any significant form of
progress in the long run without abiding to the voluntary exchange principle
and the institutional support behind it. Historical examples of this are ample.
Whenever there was even a remote possibility to gain wealth based on
voluntary exchange (or free trade) societies prospered.19 Whether this was in
ancient times of the Roman Republic, the Persian Empire, or Chinese
dynasties, or during the postindustrial era with a gradual adaptation of
democratic institutions, societies prospered when exchanges between
individuals were not bounded by any form of coercion and when people
entered into exchange on equal terms. When institutions were designed to
minimize incentives to engage in coercion during the process of exchange,
economies prospered. When institutions were designed to do the opposite,
economies stagnated.20 The greater the freedom to engage in exchange, the
better the economic outcome of a society.
The second principle is the gift exchange principle. It operates in many
forms. Anthropological research has found that a number of small
communities fostered the gift exchange culture as a predecessor to what we
know today as the market exchange. There were no monetary transactions
involved, just the necessity to repay one’s gift with another or with an act of
kindness. Even today many occupations still depend on gift exchanges. There
are various forms of charities and foundations which are financing
universities, think tanks, and cultural events, not to mention tackling a host of
social issues, from poverty to fighting diseases to basic education. The most
widespread form of the gift exchange principle are gifts received within a
family, with particular emphasis on inheritance. Monetary transactions within
a family are purely altruistic and are never driven by market exchange
principles nor do they necessarily rely on outside institutions to enforce them
(with a few exceptions, inheritance and divorce being the most prominent).
They serve the purpose of solidarity through which parents take care of their
children and when they get old, their children take care of them. No contract
is necessary to enforce this relationship. The principle of inheritance is
therefore a natural tendency of any person with children to leave whatever he
or she created during their lives to the ones they care about the most.
However, inheritance can also be the source of inequality, particularly if a
large fortune is being transferred to the benefactor. The issue of its legitimacy
is not in the act of inheritance itself, but in the source of wealth: was it
created and maintained according to the free exchange principle, which
means that the benefactor needs to operate under the same principle to ensure
the wealth is not lost, or was it created and maintained based on proximity to
political power, in which case the inheritance is rightly considered unjust.
This brings us to the third principle of securing one’s existence: the
violence power principle—the negation of the free exchange and solidarity
principles. The ability to wield violence and secure power can only be used
by a small minority within a society: the ruling elite and everyone in its
proximity. Only the ruling elite has the legitimacy to use violence and
coercion granted by its hold on power. Violent expropriation of property and
coercion of individuals into slaves dominated human societies until the
modern age and has existed throughout humanity as a permanent, latent
pattern of behavior. When the costs and risks of violence are lower than the
anticipated benefits, a person has an incentive to secure their existence
through coercion and expropriation. In premodern times the cost of theft was
minimal and the risk was low, particularly if one had no competition in theft
and could rely on weapons and soldiers as a legitimate threat. Wars in
premodern times were seen primarily as a method of enrichment of all men
who went into battle through pillaging the conquered territories. The latent
desire for violent conquest was in the human DNA ever since the Homo
sapiens started their spread from Africa onto other continents some 70,000
years ago leaving every other human species they’ve encountered extinct. It
was the dominant form of behavior throughout antiquity, the Middle Ages, the
ages of discovery and colonization, and even during the aftermath of the
Industrial Revolution.
The key benefactors of violent conflict had strong incentives to preserve
their position, to make it permanent and hereditary. They molded political
institutions to strengthen their extractive power with the help of religion as a
justification of their divine right to hold power. The result was several
millennia of slavery and feudal systems and a society confined within the
Malthusian trap of long-term relative economic stagnation, a relative
demographic stagnation, and Hobbesian living standards. Applying the
violence power principle inherently led to rising inequality where wealth
and opportunities were constrained to anyone with access to power or
proximity to power: the rulers and the nobility that supported them.
Over time, with the rise of Enlightenment and gradual development of
western European societies during colonial and postindustrial times, the
emphasis on individual freedom started replacing the dominant coercive
collectivism. Deidre McCloskey claims that the change of rhetoric and ethics
and ideology, in other words new and better ideas, were the key motivational
factors behind the Great Enrichment achieved via the Bourgeois Deal.21 The
change in rhetoric too was a gradual process, to a large extent driven by the
spread of books after the invention of the printing press in the 15th century.
Spreading knowledge via books was much more efficient than ever before,
but it took 200 years to create a generation of intellectuals and scholars—
itself a minority elite that led the Enlightenment movement.22 Nevertheless,
despite these positive changes where the voluntary exchange principle was
very slowly overtaking the violence power principle, societies are still
consumed with the latter. Centuries of philosophical and political economic
discussions on the limits of state power—that carry on until this very day—
are best proof of this. History shows many examples of attempts of special
interests to misuse the voluntary exchange principle and establish a clear
dominance hierarchy with the legitimacy over the use of violence and
coercion. In Europe this had last happened in the 20th century with the rise of
Nazism and fascism. In such cases predatory behavior, lawlessness, and
destruction become the modus operandi of political action. Even with their
defeat it is impossible to exterminate incentives for coercion based on
power. The violent power mechanism is therefore permanently present,
either dominantly or latently, in every society.
 The rise of the voluntary market exchange principle in the battle of ideas
ever since the Enlightenment and particularly after the Industrial Revolution
generated extreme levels of wealth accumulation, but it also perpetuated
extreme disparities in wealth. The question is are these disparities in wealth
purely a consequence of the voluntary exchange principle, or are there
different, nonmarket factors that can be attributed to the rise of inequality?
The argument delivered in this book is that the usage of violence based on
power has been a persistent incentive in a quest to extract wealth throughout
human history. The rise of the voluntary exchange principle, despite its
enormous ability for the first time in history to generate inclusive wealth
cannot simply overrule a principle that has guided human behavior for more
than eight millennia.
The violence power principle is achieved through institutionalized
political and economic power. Power concentrated in political parties and
government institutions whose internal structure is highly hierarchical.
Political power knows no competition. It is monopolistic and depends first
and foremost on how much the citizens hold it accountable. Without
accountability any type of government descends into the basic instinct of
autocratic decision-making and misuse of power, regardless if it operates
within a democratic context or not. Governments facing zero accountability
are free to redistribute resources however they see fit, just as any autocratic
government in history did.
Corporations are similar hierarchical institutions. Internally, their
governance structures are not democratic but autocratic. When they depend
on market principles and free competition, they are forced to adapt internally
to maintain their position on the market. However, corporations often attempt
to avoid the costs of adaptation and achieve market dominance based on
gaining privilege from access to political power. Then they are free to
transfer their costs and risk to the consumers, worsening their position.
Corporations will therefore have a stronger incentive to reduce risk and
costs by achieving a politically privileged position. They will enter into elite
network relationships in order to achieve a nonmarket way of capturing a
market position. They are encouraged by the prize in terms of nonmarket
rents. Their profits may arise from their market power, but their market
power has been granted to them by political power.
Many individuals seek to use access to power to secure a rent-seeking
position with a much lower risk and lower cost than when having to engage
in a free exchange mechanism. Access to political power is gained through
personal connections and a system of favors that build trust. Whoever enters
into such relationships has incentives to achieve a nonmarket way of
capturing a market position. Despite the fact that there is a risk of getting
uncovered or losing power, individuals enter elite networks to, essentially,
lower risk. They seek protection from politics in terms of legal or regulatory
acts, or they seek direct rents from government contracts. From the
perspective of the firm this interaction is economically rational as it involves
trading off low cost (of effort and engagement) for a great potential return
that involves reduced risk exposure. The acts of lobbying and campaign
spending for example are completely legal and legitimate ways of influencing
government decision-making. Exchanging personal favors between connected
individuals in positions of power is not necessarily always legal but it is, in
most cases, completely legitimate. Using these connections implies trading
off costs of engagement with lucrative prizes—rents.23
The incentive to join an elite network can therefore be summarized by
trading off the voluntary exchange principle with the violence power
principle. This happens whenever the costs and risks for building a position
of proximity to power are lower than the expected benefits from engaging in
voluntary market exchange. Chapter 5 develops this further.
Elite network theory is very much aligned with the North, Wallis, and
Weingast violence and social order (VSO) framework24 but also the narrow
corridor (NC) framework developed by Acemoglu and Robinson.25 We can
think of the violence power principle as a typical outcome of the natural
state, a limited access order (VSO) run by a despotic leviathan (NC), where
wealth and power are concentrated in the hands of those who have a
monopoly over the use of violence. This was the dominant form of social
organization throughout human history. Limited access orders are by
necessity dependent on kinship and close personal relationships. Governing
institutions themselves become personalized, and economic outcomes are
manipulated by the ruling elites which cater to privileged interests. All
political and economic outcomes are merely a consequence of interpersonal
relationships among agents within the ruling elite networks. Liberty is
constrained and wealth allocation is determined by the despotic leviathan.
On the other hand, the voluntary exchange principle is the foundation of
open access orders (VSO) or shackled leviathans (NC). In it, institutions are
depersonalized and subject to promoting equal opportunity and free
exchange. This makes it much harder to erect dominance-based hierarchical
orders and develop clientelistic relationships, making it much more difficult
to use violence to distribute wealth. However, maintaining such an order is
not easy nor straightforward. Institutions constantly evolve, but even when a
society enters the narrow corridor there is no guarantee it will succeed in
solving the violence power incentive that propagates the concentration of
wealth and power within elite networks. What is necessary is to impose and
maintain the Red Queen Effect26—always running just to stay in the same
place—a metaphor for persistent societal mobilization to preserve the
foundations of liberty and keep in check the power structures running the
country.
An important addition of elite network theory to the VSO and NC
frameworks is an explanation of how individuals within different political
orders adapt to the principles of securing survival, and what serves as
motivation for economic and political activity in the first place. When the
institutional order of a society is a limited access one (a despotic leviathan),
in which the violence power principle guides social interaction, elites will
form around whoever wields power. When an institutional order is an open
access one (shackled leviathan), dominated by the voluntary exchange
principle, incentives to use violence are curbed and elites adapt by engaging
in the political process in legitimate ways. But the struggle for power
remains.
Given that societies have spent most of their history as limited access
orders guided by the violence power principle of survival, any transition into
voluntary exchange takes time and considerable effort in order to curb elite
network power incentives. However, it is only within open access orders
that elite network incentives can be curbed and placed under control. Under
closed access orders, this isn’t even possible.
Once the transition from a limited into an open access order is achieved,
the issue still becomes how to curb power concentration among the elites. A
society needs a strong state and ruling elites to ignite development. But a
society also needs strong social mobilization to keep both the state and the
elites in check. Problems arise when elites become too powerful and hidden
so that society is unable to constrain their power. Hence the necessity for the
community (the “third pillar” of every society27) to involve itself into the
political process to maintain the Red Queen Effect and preserve the balance
of power between society, the state, and its elites. This argument is presented
in the final chapter of the book, Chapter 10, examining how to curb the
violence power principle by reducing centralized political power, and thus
reducing incentives for elite network usurpation of power.

I.3. Why Should Elite Networks Have Any Effect on Inequalit

y?
One of the central arguments of this book is that elite networks are and
always were responsible for the accumulation of wealth at the top. In order
to understand why elite networks carry such an effect on the distribution of
wealth and income, we need a brief historical overview of the origination of
wealth and the creation of first power structures. This argument, developed
in greater detail in Chapter 2, reinforces the logic behind the creation of elite
networks and helps understand how they generate an effect on inequality
today.
A broad consensus among economic historians and anthropologists is that
the creation of wealth came as a result of plant and animal domestication
during the Agricultural Revolution some 10,000 years ago (8,000 years
B.C.).28 Domestication created food surpluses and consequently a possibility
of food storage. Having surplus food meant that there was no need for
everyone to work in agriculture anymore, encouraging people to specialize
and do other things such as to become bureaucrats, soldiers, and rulers.
These nonproducers could then be fed from the surpluses created for the
whole society. This crucial factor of greater food production enabled the
growth of early populations and further encouraged sedentary lifestyle as
well as larger and denser societies. It was the starting point for the
origination of political and religious organizations, both of which were
crucial in enabling cooperation between unrelated individuals in large
societies. One of the underlying tasks of the political organization was to
protect the food surpluses by organizing armies. Thus, the first soldiers
emerged, loyal to the ruler who further strengthened his rule by assigning
himself divine characteristics (which is where religion comes in as the first
form of elite propaganda). Another consequence was a gradual development
of the technology for warfare (guns and swords), which was useful in later
conquests to acquire new land and amass new wealth. Therefore, the creation
of initial wealth in terms of surplus food almost instantly enabled the creation
of a hierarchical power structure that included a ruler, a military to support
him, and a religious leader that justifies his divine existence. All of these
formed the first ruling elites.
In addition to protecting food surpluses, the first proto-states also had a
role in protecting domestic population from outside violence. Olson29
describes this as a process of replacing a social disorder called roving
bandit with a stationary bandit model. People preferred the certainty of
having one ruler protecting them to the uncertainty of having a series of
roving bandits randomly pillaging them. The demand for protection under one
ruler implied granting unlimited power to that ruler, accepting his
authoritarian leadership, and accepting his use of violence to both protect but
also expropriate. As the proto-states were gradually expanding into the first
empires (Sumerian, Egyptian, Akkadian, Babylonian, Assyrian, Persian,
Chinese dynasties), and later into more powerful and organized empires
(Roman), they were at all times characterized by a hierarchical and
autocratic social order with a ruling elite at the top of the wealth distribution
—in other words a stationary bandit model. The most important artifact of
the stationary bandit model was the role of the state’s ruling elites in defining
early ownership rights over land and all types of property (including slave
labor) and enabling the transmission of wealth within a society.
Scheidel argues that the early premodern states and empires enabled the
concentration of income and wealth within the ruling elite through basic rent-
extraction. He refers to these elites as the “original 1 percent” whose
purpose was to uphold power in order to seize wealth.30 The very
distribution of income and wealth in early societies and early empires was
based on proximity to power. Any income generated from labor or capital by
the nonelites was quickly expropriated by those with proximity to political
power, leaving the vast majority of the population to live on subsistence
income. The stationary bandit model, based on extractive political
institutions—to borrow the term from Acemoglu and Robinson31—could
explain why the world had been stuck in a Malthusian trap for 10,000 years,
ever since evolving from hunter-gatherer societies. This natural economic
system where technological progress only led to population growth instead
of better living standards,32 was supported by the holders of political power.
Having or being close to political power was the only way to become rich
(in relative terms) in a Malthusian economy.
 This argument is further supported by Milanovic, Lindert, and
Williamson,33 who find that preindustrial societies (ranging from ancient
Rome and Byzantium to medieval England, Holland or France) were
characterized by a very high extraction ratio—the rate at which potential
inequality is turned into actual inequality. The higher the extraction ratio for a
given society, the greater the wealth extracted by the top income groups, and
hence the more unequal the society. Essentially, they confirm the idea that
extractive and repressive ruling elites were responsible for creating and
maintaining unequal societies.
To sum up, political inequality, or the inequality in the distribution of
power, was the primary source of income and wealth inequality ever since
our species evolved from hunter-gatherer societies. This artifact of societal
development was, and still is, a key characteristic of many states and nations
—all, in fact, which have had or still have some type of authoritarian rule.
After the fall of the Roman Empire, medieval kingdoms replaced the earlier
structures and enabled the extractive stationary bandit model to spread out,
giving rise to the first nobles as the supporting elite group of the ruler. Their
political power gave them the right to own land, (slave) labor, and ultimately
amass large wealth. The medieval nobility and the elites that were created at
the onset of the Middle Ages, as well as the fortunes that they’ve amassed are
still in the upper tail of the income distribution until this very day.34 Clark’s
natural law of social mobility predicts a regression to the mean over time for
elites and impoverished groups, however this regression is very slow; it can
take up to five hundred years for an elite family to regress to the mean. The
seeds of today’s inequality were therefore planted during times of stationary
bandit extraction-based politics. This is the legacy that elite networks have
had on the distribution of income and wealth.
Piketty’s seminal contribution testifies to this argument.35 His long-run
verdict is that European inequality of the 18th and 19th century was driven
primarily by rentiers and income from capital. This was, in fact, a
characteristic of all traditional agrarian societies. The pre-20th-century elites
lived on rents they extracted from their ownership of inherited capital and
land. The upper decile of income earners owned over 90% of total wealth in
a country, where the top 1% (kings and nobility) owned about 50%–60% of
it while the other 9% (landed gentry and clergy) owned the other 30%–40%.
A vast majority of people owned almost no wealth at all. Gaining wealth—
land or capital—was possible either through expropriation, carried out by
the rulers themselves, or by inheritance, which is how wealth got transmitted
among the nobility and gentry. The income hierarchy of pre-20th-century
societies was therefore dominated by capital as the main source of income.
This means that a person was much better off to inherit wealth rather than to
earn it. A top 1% inheritor had about 2.5 times more income than a top 1%
labor earner. No job could be as lucrative as owning land or capital.
Piketty’s fundamental force for divergence—where the return on capital
(r) is bigger than the economic growth rate (g)—was a defining force of all
agrarian and pre-20th-century societies. These were societies which had a
high concentration of wealth among the elites in addition to a high level of
persistence of wealth in the hands of the elites. Even after revolutionary
periods this artifact did not change. Clark shows this perfectly on the
example of China’s Communist revolution, which despite being determined
to purge the country of its “class enemies”—the landlords and businessmen
—still has these “class enemies,” originating from the same elite surname
groups of the late 19th century, overrepresented in the top earner groups in
modern-day China, and are even present in the highest structures of its
Communist Party. In general, Clark’s conclusion for a number of countries
(Sweden, United States, United Kingdom, China, India, Japan, Korea, and
Chile) is that social mobility across all societies tends to be very low
regardless of any societal changes, including revolutions, major policy
reforms like the introduction of the welfare state, or even ground-breaking
events like the Reformation, the Enlightenment, or the Industrial Revolution.3
6
It was not until the beginning of the 20th century when the structure of
capital started to change and its value relative to national income started to
decline. The two world wars and the Great Depression between them
marked the ultimate downfall of the rentier and made the shift from what
Piketty calls a “society of rentiers” to a “society of managers,” or a “society
of superstars.” In other words, the top decile of the income distribution has
ever since consisted mostly of individuals who live on wages instead of
rents, i.e., from labor instead of capital. Today the top 1%—the new elite—
are the top managers (CEOs, presidents) of global companies and
entrepreneurs who created entirely new industries. Their income is mainly
determined by labor, however they do also benefit from exposure to financial
markets through capital income and returns on investments (e.g., equity
positions and dividends).
 The structure of the elites had changed in the 20th century. However, their
resulting effects remain the same. Atkinson, Piketty, and Saez attribute the
rise of inequality since the 1970s in the United States (but also in other
Anglo-Saxon countries) to the rise in incomes of the top 1% and top 0.1% of
income earners, where salaries and capital gains from stock investments
represented the largest contributor to this increase.37 The so-called rise of
the supersalaries of top managers, a consequence of a multitude of factors
that include an increasing demand for top talent (the superstar effect),
significantly advanced not only their position in the income hierarchy but
also, more importantly, their position in the social hierarchy. Furthermore,
Bakija, Cole, and Heim confirm that 60% to 70% of individuals in the top
0.1% of the income distribution are top managers of global companies, most
of them in nonfinancial industries.38 By all means of measurement this group
is the new elite.
Supermanagers signal their importance to their organizations by having
access to a wide network of influence. Their degree and betweenness
centrality (the positioning of an individual in a key space of a network where
he or she is highly connected to all other nodes) enables them considerable
power in justifying their own abnormal earnings (abnormal in a sense that
their total compensations are higher than their productivity). Chapter 4 will
uncover which effect is more important—being connected to a lot of people,
or being connected to the key people in politics.
Historically elite persistence was always closely correlated with
political power. One could not maintain its dominant position in the social
hierarchy without being somewhat dependent on the ruler. Today, this
relationship, although different in the scope of political power the ruler can
use to expropriate its subordinates, is essentially the same as before. The
power of a ruler to take away human lives has vanished in democracies (at
least in domestic affairs), however the ruler still has enough power in terms
of budgetary redistribution so that his role attracts anyone dependent on these
resources, be it various interest groups seeking to gain public resources or
special treatment for its members, or firms seeking to gain regulatory,
legislative, or other form of advantage over its competitors. Furthermore, it
has been shown that supermanagers often use their political power to lower
top marginal income tax rates or finance various NGOs so as to indirectly
promote their cause.39 This too can affect the rise of top incomes and widen
income inequality.
 Arguably this political effect—lobbying and using campaign donations to
persuade politicians to make legal changes in the tax codes—is part of a
much wider network effect. The way a supermanager gains access to a
politician is not through some crude and well-defined institutional
mechanism where more campaign funding automatically transfers into
favorable decisions for the giver. No, influence is gradually constructed
through a series of informal meetings and gatherings, where favors are
exchanged between powerful individuals. This is the foundation of an elite
network.

I.4. The Cyclicality of Inequality

Inequality is a cyclical phenomenon. Its cyclical nature implies that the elite
network framework used in this book needs to be able to explain why
inequality sometimes goes up and why it sometimes goes down. If inequality
and concentration of wealth within a select narrow elite are indeed
consequences of political power, and if hierarchical political orders led by
autocratic rulers were indeed the dominant sociopolitical orders ever since
the Agricultural Revolution, well into the 19th and 20th centuries, then the
logical conclusion is that inequality should have been very high and
relatively stagnant during the entire history of mankind. Elites always existed
and they always successfully extracted and concentrated wealth due to their
access or proximity to political power. However, even if inequality observed
during preindustrial times tends to be really high in certain time periods and
certain areas (wealth inequality Gini coefficients used to be as high as 0.8
and 0.9)—it is never relatively stagnant. On the contrary, it is quite dynamic.
The Kuznets theory had a very simple inverted U-shaped explanation
where inequality tends to be low for lower levels of economic development,
then it significantly increases as society undergoes a transition to an
industrial society, after which it starts to decline due to forces of
modernization.40 This theory was limited to its historical context: Kuznets
was observing the pre- and postindustrial trends in inequality until the 1960s
when he made his seminal contribution. However, the Kuznets theory fails to
explain the U-shaped inequality trends that occurred by the end of the 20th
century. It should have never happened in developed societies. This is why
Milanović suggests that inequality moves in cycles, so-called Kuznets
waves, thus explaining the peak after the Industrial Revolution, the trough
after the wars in the 20th century, and the new peak at the end of the 20th
century. Milanović argues, rectifying Kuznets, that the 20th-century upswing
in inequality that falls beyond the scope of Kuznets’s original model is, in
fact, a second Kuznets curve appearing in modern times and is being driven
by the same forces that drove the first Kuznets curve—advancements and
innovations in technology driving a shift from manufacturing into services
(just as the first Kuznets wave was driven by a shift from agriculture into
manufacturing), and the effect of globalization which increased concentration
of returns from both labor and capital at the top. The decline of inequality in
preindustrial times, according to Milanović, was driven by random events
like wars, epidemics, or new discoveries given that there was no
relationship between relatively stagnant incomes and inequality in
preindustrial times.41
The only thing missing from the Kuznets waves theory is an explanation of
inequality trends in the very long run. It is an excellent toolkit for
understanding modern cycles of inequality since the 19th century, but it does
not deliver a theoretical justification of why inequality moved upward since
the first settler societies, throughout antiquity and the Middle Ages, and
during modern times, both pre– and post–Industrial Revolution. Random
exogenous events might have exerted pressures to lower inequality, but the
reason for its persistent upswings is deeply rooted somewhere else. This
book provides an answer to the crucial question: What is the main driving
force behind inequality throughout human history?
The elite network theory recognizes two forces that affect the cyclicality
of inequality over time. One force pushes inequality up constantly, while the
other force pushes inequality down occasionally. The occasional force,
which I will call the force of occasional destruction, is composed of four
types of events, some endogenous, some exogenous, all perfectly
encapsulated in Scheidel’s theory. These are the Four Horsemen: war,
plague, state failure (dissolution of empire), and revolution. Scheidel makes
a powerful argument that whenever there was a significant leveler of
inequality in history it was driven by or was a consequence of one of the
aforementioned catastrophic events.42 Both Piketty and Milanović agree that
20th-century leveling of inequality was to a large extent due to the impact of
the two world wars, although they do emphasize the role of social reforms
and the rise of the welfare state that added to the gradual leveling of
inequality until the 1970s (Milanović calls them benign forces that were only
possible in postindustrial societies with rising mean incomes43). Franchise
extensions, welfare state reforms, and demands for redistribution all arose
internally in the 20th century, potentially as a consequence of social
rebellions against high levels of inequality. These too can be considered as
occasional forces, arising endogenously. Scheidel on the other hand
dismisses the benign force theory by arguing that the demand for these
reforms (like the extension of the franchise after World War I or the
expansion of the welfare state after World War II) came as a direct
consequence of the wars. Even the rise of socialism, first in Russia in 1917
and later across Europe and the world can be attributed as a consequence of
the wars.44
In other words, there was no natural force—like modernization or
economic development—that led inequality down, at least not significantly.
There were only large-scale unpredictable events that happen randomly and
eventually served the purpose of leveling the inequality trend. Whenever
such an event happens the powerful elites and their wealth are affected. They
are either ousted and removed from access to power (in a revolution or
during state failures), killed (during plagues or epidemics), or have their
wealth destroyed (in wars). In each case the source of power is altered and
elite members shift their relative positions within a society. This does not
mean they become extinguished—Clark shows that elites can be quite
resilient during long periods of time.45 The elites merely adapt, but this
adaptation takes time, so there is a prolonged period before inequality starts
going up again.
Which brings us to the first force, one that pushes inequality up constantly.
This force is an artifact of elite entrenchment and political power, and a
consequence of elite existence throughout history. I call it the force of wealth
concentration. During uninterrupted periods of economic development
political power is used to expropriate newly created wealth and this has a
tendency to concentrate within the elites. Throughout history, particularly
during preindustrial times, whenever there was rapid economic development,
it was contingent on political power. Autocratic political orders always
featured extractive ruling elites. The ruling elites and their networks had
incentives to expropriate wealth and were driving the concentration of
wealth during periods of economic growth and expansions. This was
particularly prominent during the Industrial Revolution when inequality
reached significantly higher levels on the wave of rapid economic
development driven primarily by those with access to political power and
privilege. It is also true in any modern society which has economic growth
contingent on political power; and in any preindustrial society where
economic growth was limited within the constraints of the Malthusian trap. In
each case, whether we are observing a premodern society captured in the
Malthusian trap or a modern society captured by entrenched political and
corporate elites, their mere existence was what made wealth concentration
high. The only way for inequality to subside was a war, an epidemic, or a
similar major disruptive event. Only when the elites were disrupted was it
possible for inequality to go down.
Figure I.1 depicts the theory of cyclical inequality when faced with the
two major opposing forces. Note that the force of occasional destruction is
always stronger but given that the leveling from this force happens as a
consequence of a short-run event, its effects are deep but they soon subside
and societies can once again move in the direction given by the force of
wealth concentration.

Figure I.1 The cyclical nature of inequality is driven by two forces, one pushing up constantly, and the
other pushing down occasionally.
A further theoretical justification of the force of wealth concentration can be
found in Olson’s 1982 classic, The Rise and Decline of Nations. Olson
argued that stable democratic societies have in-built mechanisms that
encourage the rise of special interest power. According to Olson’s logic,
prolonged political and economic stability will gradually lead to an
accumulation of power of special interest groups. Derived from his central
theory on collective action, Olson suggests that many individuals will not
actively seek to form groups even when it is in their best interest to do so
(when the gains of organizing would outweigh the losses). On the other hand,
smaller groups with a narrower focus will form because they have a strong
incentive to solve the free rider problem and impose collective action among
their members.46 From this he derives several propositions on how the logic
of collective action should impact economic outcomes (economic growth in
particular).
The first one is that special interest groups accumulate gradually over a
long period of time, and its accumulation of power is limited to societies
with a “continued freedom of organization.” He predicts that societies which
did not have any major disruption in the formation of its interest groups (like
the United States or the United Kingdom) will see their interest groups
growing stronger over time. Their accumulation of power in stable societies
will, over time, reduce economic efficiency and result in what Olson calls an
“institutional sclerosis.” The longer the time of stability in which such groups
operate, the stronger their negative effect on economic growth. If, however, a
society develops only “encompassing” groups which include the majority of
members of a society within them, only then will they render a positive effect
on economic growth as the benefits achieved by such groups will be
distributed across a wide range of its members thus making most people in a
society better off.47
Following the same reasoning, a prolonged period of stability will
gradually lead to an accumulation of power in the hands of elite networks,
where powerful interests will successfully fight to preserve their status quo.
Therefore, a necessary outcome of prolonged stability will be an
accumulation of elite network power that could retard economic growth, as
anticipated by Olson, but also curb institutional rules to their benefit—like
the use of violence, theft, and expropriation—at the expense of the rest of
society. Long periods of uninterrupted stability, because of the accumulation
of power within well-organized elite networks, can be attributed to wealth
concentration among the elites, and hence serve as a potent motivational
factor behind inequality. This is a powerful force that is realized
automatically, whenever there are no disruptive events that halt its progress.
To sum up, inequality is a cyclical phenomenon because random events
affect the allocation of wealth within societies. Absent from violent random
shocks societies would have persistent wealth accumulation in the hands of
elite networks and very high and stagnant levels of wealth and income
inequality, led by the forces of wealth concentration. However, because of
violent shocks—the forces of occasional destruction—elite networks will
occasionally be disrupted and inequality trends will be leveled. The long
period of (relative) stability will once again give rise to the forces of wealth
concentration and the cycle is completed.
None of this suggests that elite-driven inequality is imminent nor that it is
a fact of life that can be justified. There are ways to constrain the forces of
wealth concentration outside causing violent disruptive shocks. The problem
is that throughout history societies have seldom recognized its true causes,
obviously failing to ever truly address them. As this book shows, the root
cause of the forces of wealth concentration and by extension the upward
trends in inequality, is political power. The final part of the book will
address the specific sets of reforms necessary to redistribute political power
from centralized office-holders to citizens and communities. It is envisioned
as a long and continuous process, resting on the democratic trial-and-error
mechanism gradually rebuilding trust in social and political institutions.
Inequality is a trend that accumulates over time. Its remedies also need time
to accumulate enough social capital to deliver the expected effect. Simple
redistribution of unequal incomes will not suffice. Time has come to change
the way we think about the causes of inequality.

I.5. What This Book Does Not Do: External Validity Limitatio
ns and Potential Extensions
The book delivers theoretical and empirical validation of its hypotheses. The
chapters presenting empirical results primarily address the internal validity
constraints. However, they do not touch on any external validity issues.
Furthermore, the measurement of an elite network presented in the empirical
chapters is a mere approximation, as interactions between its members are
difficult to uncover, yet alone measure. The closest I’ve come in accurately
defining an elite network is in Chapter 4, where I directly implicate top
executives who associate with politicians on an informal basis (via
memberships in the same clubs, societies, and associations) or who used to
work together. A similar, although less restrictive approximation of an elite
network is given in Chapter 7, where the key was to implicate firms, looking
at the benefits firms get if they donate money to political campaigns, lobby
politicians, or have former executives who used to work in government. The
most lenient approximation is given in Chapter 6, where I discuss research
linking political survival to suspicious procurement contracts given to firms.
Each of these approximations offers the best definition given the available
data.
Furthermore, the scope of the book is limited only to the countries that
were examined. The impact of elite networks on inequality was shown only
for the United States and the United Kingdom. Second, each case provides an
entirely different and very specific context, meaning that I could not show on
a single dataset for a single country how both politicians and firms benefit,
nor how their mutual benefits carry an indirect effect on inequality. The
overall conclusion is drawn from specific cases, which raises a slight
concern over the generalization of the hypothesis. Third, the estimated
empirical effects are in most cases local average treatment effects
(constrained within a specific as-if random context), making it even more
difficult to generalize the conclusion to all countries and all cases.
To make the argument externally valid I would need to directly
approximate elite networks across different societies in the same way as
presented in parts of the book, and observe how it differently affects
inequality in each of them. If greater inequality is indeed rooted in politics,
as the book aims to show, I should observe cross-country differences in
inequality based on the differences in how connected the corporate sector is
to politics. In particular, I would need to show that in countries where top
executives are not as closely connected to politics as they are in the United
Kingdom or the United States, earnings are distributed more equally. If low-
inequality countries are indeed mostly deprived of these types of connections
at the highest levels (i.e., if they have institutions that prevent elite networks
from abusing power), then we could make the conclusion that politics is an
important determinant of higher inequality. If, however, this is not the case,
the conclusions of the book would only suffice for a limited sample and
perhaps even a limited time period.
 Furthermore, in Chapter 4 the findings are limited with how long it can
follow the origins of an elite network. The data can only be traced back until
the year 2000, meaning that I present a rather static image of the impact of
connections on wages. In particular, better connected executives have had
consistently higher salaries and higher total earnings throughout the observed
16-year period. There is unfortunately little data on people entering into elite
networks in the sample (senior executives tend to be older and if they are
entrenched, they tend to be entrenched for long periods of time, and certainly
prior to my first point of examination, the year 2000). A potential extension
would be to get data that would allow tracing this process back in time until
the 1950s, 1960s, or at least 1970s, and see if the documented increase in
income inequality since the end of the 1970s was indeed preceded by the rise
in power of elite networks. In other words, did US and UK senior executives
started forming closer ties to the government just before the observed rise in
income inequality, or is this relationship merely a persistent peculiarity of
these two countries (epitomized by WASPs in the United States or Old
Etonians in the United Kingdom) that is not necessarily tied to rising
inequality?
Even in the case of obtaining a longer time-series of political connections,
it would still be necessary to observe the same relationship cross-country to
determine if it holds. The problem here, even if we assume that we can
approximate for elite networks in other countries, is in the comparability of
the data. In the US and UK samples, elite networks are proxied via a very
specific indicator: whether executives used to work in politics or are
connected to politics via personal relationships. If a similar proxy could be
found in other countries it would have to measure the exact same thing in
order to make the cross-country comparison possible.
Overall, despite the limitations in satisfying external validity of the
argument, the empirical chapters of the book do provide a useful blueprint
for further research on the topic. They provide empirical backing of the
argument that political factors could be an important determinant of
inequality, even if this result is limited to a specific context and time period.
Any further research on this topic, examining the political causes of
inequality, should approach it from the same perspective: try to get an
individual-level and firm-level dataset across different societies to measure
the impact of connections on income dispersion. Further research can be
aimed at a more precise definition of elite networks, but simple enough for it
to be easily measured in any society. This is a difficult task as elite network
interactions are always hidden, however some interactions and particularly
some outcomes based on informal networks can become visible and hence
measurable.
Second, a very useful extension would be to capture the rise of power of
elite networks over time. Are they indeed robust to political and economic
systems, as is assumed in the book? How volatile is the accumulated power
of elite networks across different societies? Do they vary in influence from
one decade to another, or is their influence persistent? The assumption is that
elite network membership is dynamic—all members are limited by the
duration of their tenure, and ultimately by biology. What is the effect on
society when these changes occur and when important members leave the
group? Or is there no effect at all, given that the position of power of the
person is what makes them a valuable member, not necessarily the person
himself. To continue in this direction, one would have to combine the
sociological and anthropological studies on elite groups with the political
economy implications given in this book.
Third, the findings of the book could help provide empirical backing to
Olson’s argument that post–World War II stability increased the power of
special interest groups which resulted in slower economic growth. Olson’s
lucid theory of interest group capture from the Rise and Decline of Nations
has never really been empirically justified. This book provides a good
starting point of the type of analysis that would be necessary—to observe
individual-level connections between politicians in power and the managers
and financial backers of powerful interest groups (NGOs, corporate lobby
groups, advocacy groups, religious groups, etc.).
Finally, a useful extension would be to examine whether elite networks
carry a similar impact on social mobility and the equality of opportunity. The
mechanism is slightly different than the impact on inequality presented in the
book. It materializes through hiring decisions on the labor market, where if
an individual is not a member of the network, he or she is prevented from
climbing the social ranks. In other words, an individual can only reach the
top of the corporate or political hierarchy if on that road he or she accepts
the mutually dependent favor exchanges with influential individuals. This
would be almost impossible to measure directly, unless we could measure
the negative effects on connected individuals when a person drops out of an
elite network because of, for example, imprisonment.
 Before any of these efforts are conducted, and before the theory can prove
it is externally valid, the conclusions remain: politicians and firms in
specific contexts do collude together and derive benefits from their
interactions. These benefits to both groups hurt society as they make the
distributions of incomes more unequal by pushing up the incomes of
politically connected top earners. Politics is therefore an important factor
that should not be overlooked when examining the causes of inequality.

I.6. Structure of the Book

The book is divided into three main parts, preceded by Chapter 1, which first
defines the concept of elite networks. It provides a formal definition,
discusses the logic behind their creation, and provides several visualizations
of the most obvious examples of elite networks, with an emphasis on network
superhubs in finance and politics. It then draws a map of political
interactions and uses Olson’s logic of interest group behavior based on their
relative power and salience to place elite networks on that spectrum. Finally,
it describes how to quantify and establish elite network outcomes. Part I then
sinks its teeth immediately into the main relationship of interest: does the
existence of elite networks, a historical axiom, affect the distribution of
income in a society and in which way?
Chapter 2 delivers the cornerstone historical argument depicting the
mechanism between elite networks and inequality. It follows several
theoretical and empirical contributions in the inequality literature to argue
that inequality exhibits incredible persistence over time. One of the reasons
for this persistence of unequal income and wealth distribution in addition to
low social mobility has to do with the accumulation of power at the top.
Before the Industrial Revolution our societies were molded by autocratic
rule in which wealth was fully expropriated by the ruling elites. After the
Industrial Revolution, societies experienced the rise of rentiers who earned
wealth based on ownership of land and capital, but whose position was also
cemented thanks to political power. In modern times a new elite network is
being formed: it is no longer composed of nobility (as before the 18th
century) and various rentiers (as in the 18th and 19th centuries). It is
composed of corporate managers with links to political decision-makers.
The rise of the “supermanager” in terms of salary and total compensation is
the biggest explanatory factor of rising inequality in the West. The argument
of the book is that this is due, in part, to political connections that
supermanagers caress, and through which they signal their importance by
having access to a wide network of influence. Their degree centrality enables
them considerable power in justifying their own abnormal earnings.
Chapter 3 focuses on contemporary trends in the rise of democracies, the
rise of government spending, and the rise of inequality in the second half of
the 20th century. It suggests that even with democracies evolving to make
capitalism beneficial to all, and even when most people today enjoy far
greater living standards than ever before (governments providing public
goods and freeing entrepreneurial spirits), this mechanism has failed to
sustain the rapid growth in wages of the top income earners (1% and 0.1%).
It provides a theoretical discussion as to why this might be the case. This
chapter also surveys the alternative explanations and evidence on rising
income inequality.
Chapter 4 summarizes the empirical evidence that confirms the theoretical
intuition laid out in the previous two chapters. It uses a large database of
corporate executives of publicly listed companies in the United States and
United Kingdom in order to directly measure how they might be connected to
politicians. A political connection implies any channel through which a top
ranked corporate executive could form an informal interaction with an office-
holding politician, be it through their previous careers, or through
membership in the same organizations such as country clubs, foundations,
charities, church or religious groups, professional organizations, etc. Once
such an informal relationship is established, favors can be exchanged; the
executive gets beneficial regulation or government contracts, and the
politician gets campaign donations or direct bribes. After the executive
successfully extracts rents for his firm, he demands a higher compensation as
a reward for his efforts. The empirical evidence supports this hypothesis and
finds that politically connected executives, by assumption elite network
members, tend to have higher salaries and total earnings than nonconnected
executives.
Part II is designed to show both the theory and empirical findings of why
members of an elite network—politicians on one hand and firms and their
executives on the other—have an incentive to be part of it. The first chapter
of Part II, Chapter 5, builds on Chapter 1 and exposes the logic of elite
network formation. It delivers a network theory and an economic theory
explanation behind elite network formation with an emphasis on its high
levels of betweenness centrality and homophily. Elite networks are shown to
be highly topocratic, meaning that they condense wealth-seeking
opportunities and privileged information within narrow powerful groups. It
then adds a cost-benefit analysis to understand under which conditions
individuals enter such groups, and finally, it dives deeper in the three
historical principles of how people mitigate risk in order to survive. Given
that societies were entrapped for centuries under the violence power
principle it is difficult to simply break up elite networks arising from it.
Chapter 6 presents theoretical and empirical justifications and
explanations of why politicians would enter an elite network type of
relationship. They benefit in two ways: preserving its position of power
through building small winning coalitions, and by directly or indirectly
extracting rents. This is where elite network theory meets the selectorate
theory and paints a complete picture of the motivation of political survival.
Rents can come in the form of bribes and kickbacks to direct usurpation of
office for private gain. The chapter concludes by presenting empirical
findings linking corruption, in the form of rent-extraction, directly to re-
election possibilities of politicians. The data is drawn from the case of
Croatia, where corruption has been directly approximated using fraudulent
procurement contracts.
Chapter 7 looks at the firm and how its rent-seeking activities, in the form
of exclusive government procurement contracts or favorable legislation and
regulation, get realized through an elite network. It delivers the key
distinction between two main types of firms: rent-seekers and customer-
seekers. As long as elite networks render effects that favor rent-seekers,
adverse socioeconomic outcomes are inevitable. The chapter concludes by
examining the empirical evidence showing how politically connected banks
in the United States benefited the most from the 2008–2009 bailout
allocation.
The final part deals with the remedies. Based on the main finding of the
book—that inequality is rooted within political power—it attempts to show
how and why lowering political power is the only way to curtail the forces
of wealth accumulation. Chapter 8 delivers another necessary historical
context, explaining the rise of capitalist democracies, from the early unjust
exploitative capitalism, led by the pure violence power principle, to its
gradual convergence into a much fairer democratic capitalism. Despite its
early unjust outcomes, capitalism managed to deliver an impetus for
persistent social change, eventually resulting in political changes, as the old
aristocratic elites were being replaced by democratic governments. This
permanent incentive for change gradually started delivering basic human
rights, as well as equal representation, rule of law, equality before the law,
equality of opportunities, and eventually equality of gender and race. All of
this was achieved under capitalist democracies, through a unique trial-and-
error mechanism that helps societies learn from their errors, never again to
repeat them. This was the reason why social progress became unstoppable
after a period of terrible events of the first part of the 20th century.
Democracies reformed from within, pledging not to repeat the errors they’d
made. Socialist countries also achieved rapid progress in the aftermath of the
Second World War. However, when faced with their first major internal
crisis, they crumbled under pressure as they had no trial-and-error
mechanism that could help them overcome the crisis.
The unstoppable progress that lifted living standards and dramatically
reduced poverty in the second half of the 20th century failed, however, to
solve the issue of inequality. Inequality is driven by different forces, rooted
deeply within political power. This does not mean it cannot be dealt with,
but in order to curb its incentives successfully we must set the target toward
its causes. This is why, as Chapter 9 will uncover, progressive taxation and
greater redistribution will not be successful in solving the problem
permanently—they are focused on the consequences (unequal incomes), not
the causes. Granting too much political power to individuals to solve the
issue of inequality leads to personalization of governing institutions, adverse
selection into politics and eventually declining trust in public institutions.
This is the opposite effect of what we need to contain inequality.
The context delivered in those two chapters opens up room for reform
proposals in Chapter 10 on how to reduce and limit political power, reduce
incentives for elite network formation, and consequentially lower inequality.
These are presented in the form of three powerful levers whose goal is to
exploit the democratic trail-and-error mechanism in order to rebuild
interpersonal trust and trust in public institutions, and through second- and
third-order effects increase civic engagement, improve selection into
politics, depersonalize governing institutions, turn politicians into true
servants of their people, and empower both citizens and their communities.
The First Lever is a set of reforms aimed at lowering centralized political
power. It includes full budgetary transparency, the necessity of free media
and investigative journalism, the introduction of term limits and strict
punishment of political transgressors, calls for lesser discretion and more
rule-based politics (introducing key performance indicators for politics), and
the reduction of the scope of centralized government activities, shifting more
public good decisions directly to citizens and communities. The Second
Lever is a set of reforms aimed at empowering citizens. It aims to give
citizens more power in allocating their tax contributions to the public goods
they wish to build, in choosing exactly which public goods they want their
local governments to deliver, and in offering them a credible threat in the
form of punishment referendums of governing officials. Finally, the Third
Lever is a set of reforms aimed at empowering the community, with the idea
of giving greater redistributive power not to local governments, but to the
community directly in all choices of local public good allocation.
Simultaneously applied, all three levers will gradually, and with
significant errors expected along the way, reduce centralized political power,
improve selection into politics, improve trust and democratic capital, reduce
incentives for elite network formation, and finally, reduce inequality. It is by
no means a one-size-fits-all solution, nor is it a set of policies that can
deliver immediate change. The very usage of the term “lever” is to signal that
these reforms gradually change people’s incentives and behavior, which will
eventually lead to improved social outcomes. It is a very long and difficult
path, but it is the only path that enables democracies to deliver its greatest
benefit—a rule of the people, by the people, and for the people.
 1
Why Study Elite Networks?

Among the Davos attendees are many titans of finance who pull the levers of the global
financial system. This system is not simply interlinked by institutions and transactions, but it is
fundamentally a human system, because on the most basic level it is the result of human
interaction. Understanding the interconnections of the key players is vital if we want to
understand the system as a whole.
—Sandra Navidi (2017) Superhubs, p. 5

1.1. Defining Elite Networks: Informal Mutually Beneficial In

teractions between Political and Corporate Elites
Figure 1.1 sums up the basic logic of elite network theory: informal social
networks are created between politicians in power and top executives of
politically connected firms so as to benefit all agents within the network.
Politicians satisfy their interest by staying in power and extracting political
rents in the form of donations, bribes, and other favors, while executives
manage to get exclusive government contracts and favorable regulation for
their firms. Based on acquiring these direct rents, firms reward their top
executives with higher salaries which consequentially increases the
divergence between top income earners and everyone else. This is an avenue
that has been mostly neglected by the inequality literature, but its mechanism
is potentially the missing link in understanding the true underlying causes of
inequality.
Figure 1.1 The interaction between political and corporate interests within elite networks provides
another, thus far unrecognized, avenue for explaining higher levels of inequality.

Rents for firms correspond to the standard definition of rent-seeking

according to the political economy literature.1 Firms use their connections to
government to gain a significant advantage over their competitors, be it
through direct government subsidies and procurement contracts, favorable
legislation or regulations, or by gaining other forms of privileged access or
control over a good or service. In other words, rents are an outcome of the
political process. Corporate and political institutional capture ensure lower
risk for network members and enable them to capture a non-market-generated
source of income. This additional source of income (on top of the innovation-
driven or opportunity-driven market share) is not being achieved via regular
market transactions, but is rather a consequence of capturing political
benefits. Rents are thus deliberately defined broadly to include everything
from barriers to entry, favorable tax policies, subsidies, market power,
protectionism, etc., as these politically generated benefits reflect themselves
in the differences in nonmarket earnings realized by firms that achieve them.
Obviously, they differ from industry to industry, they differ in scope and
context, but the focus here is more on how they benefit those who capture
them, and how they represent a direct outcome of the elite networking
mechanism, as described in Figure 1.1.
The focus is also on individuals who benefit from being connected to
politics. The purpose of being connected is to generate politically driven
nonmarket returns for firms. These politically captured returns enable the
connected individuals who achieved them to claim a more important role
within their firms. The individual-level empirical findings presented in Chap
ter 4 suggest that political connections are a powerful mechanism of
translating the misuse of power into abnormal earnings. Obviously, not every
member of the top 1% or 0.1% of income earners is connected with politics.
There are many, in fact, who generate their wealth purely from innovation,
expertise, knowledge, or value added provided. But those who are connected
tend to derive a significantly higher monetary compensation (compared to
their nonconnected peers) because of the connection. It is these types of
individuals, coalesced within an elite network, which are the focus of the
book, and it is through these groups that we get to observe how the misuse of
the political process gets translated into inequality. Rents and inequality are
outcomes of the same power capture process. And just a rents can be
lowered and disrupted by changing economic policies (an outcome that has
happened throughout history), so too can inequality be lowered by changing
the right policies focused at curbing incentives for a power grab.
The literature captures this indirect relationship between rent-seeking and
inequality. For example, Dabla-Norris and Wade formalize a model where
only wealthy agents engage in rent-seeking to protect their wealth.2 Demand
for protection is achieved through the influence wealthy agents exert over
politics, implying that both rents and inequality arise as outcomes of that
process, much as the elite network theory suggests. Stiglitz argues that the top
1% originates in the United States mostly originate from rent-seeking
activities instead of market innovations,3 while Furman and Orszag add some
empirical backing to this story by finding that the most profitable US firms
who pay the highest salaries and thus increase between-firm inequality draw
their higher returns not from innovation but from rent-seeking.4 This finding
is further strengthened by Song et al. and Autor et al.,5 who find that
between-firm differences in incomes are the key drivers of inequality given
that high-paid workers tend to cluster in bigger and more successful,
superstar, firms. A lot of such firms reached the stage of their life cycle
where they hire corporate executives with political connections who help
them mitigate certain regulatory requirements (the Big Tech industry being a
good example—achieving market status via innovation, and protecting it via
rent-seeking). Finally, Lindsey and Teles use case studies of regulatory
capture to show how firms that stifle competition divert resources and wealth
toward the elites.6 Each of these findings strengthens the theoretical
arguments of the book. Not a single rent-seeking activity is possible without
the necessary collusion between power-holders in the corporate and political
world.
The misuse of power is not necessarily limited to interactions with
politicians. It also happens within the corporate world. Piketty, Saez, and
Stantcheva find that, when top tax rates are lowered, corporate CEOs resort
to aggressive bargaining with their boards to push their incomes up, through a
channel they also refer to as rent-seeking. The alignment with the argument of
this book is that CEO compensation—during periods of low top tax rates—
tends to go up as a result of a power struggle rather than a productive effort.
In other words, the growth of CEO compensations, which puts upward
pressure on top 0.1% inequality, is not due to innovation or greater efficiency
of their businesses, but due to their own clout over their boards. Elite
network theory adds an additional dimension here; it’s not just the basic
power play between managers and owners, it’s a much more subtle way of
turning political favors into corporate bargaining power.
The biggest contribution of the book is to observe the collusion between
agents of power, first in its historical context to generate a theory of elite
network behavior, and then empirically on an individual level, to capture the
connections between individual politicians and individual corporate
executives. The goal is to show how agents forming informal elite networks
through the misuse of power drive higher incomes for many top income
earners. The misuse of political power is the crucial root source of
inequality.
The historical roots of high inequality have been documented by Scheidel.
His argument is that high levels of inequality are a persistent socioeconomic
phenomenon that can only be temporarily reduced via violent events like
wars, revolutions, or epidemics.7 What we noticed in the post–World War II
period was therefore only a temporary decline of what is otherwise
permanently high inequality. Things did change, however. Piketty notes that
the wealthy of the second half of the 20th and the 21st centuries are no longer
rentiers living off land and inherited wealth, but corporate executives, or as
he calls them “supermanagers,” living off their abnormally high salaries.8
The abnormal part is the key driver of present-day inequality, and as this
book shows, it is driven by the misuse of power.
 Levels of inequality, however, differ among countries. Therefore, one
prediction arising from this theoretical model is that we should observe
higher levels of inequality in every society where corporate interests are
heavily interlinked with governments and political power. Societies where
its biggest corporations grow due to politically generated revenues, which
they acquire through personal relationships between their executives and
political decision-makers, should have higher levels of inequality (measured
as the income share of the top 1% income earners) than societies where this
practice is limited.
This prediction will not be tested empirically between countries in the
book, as there is unfortunately not enough country-level data on individual
political connections to make that inference. Rather, the book will show and
explain how modern elite networks function within countries, how they
benefit their interconnected participants, and measure the extent of their
influence on the increasing disparities in earnings. The focus is specifically
on the United States and United Kingdom, two developed, high-income
countries with good institutions, but with higher inequality than in other
developed, high-income countries.

1.1.1. Does It Pay Off to Be Part of the Network?

An elite network is a group connecting political elites to a number of
powerful individuals within a specific political jurisdiction, be it the entire
country, region, city, or municipality. Individuals within such groups are all
bound by their common interest: preservation of their position of power.
Elite network members, in addition to politicians, can either be wealthy
individuals, typically owners of big companies with a specific agenda that
are usually main campaign donors; corporate executives from public or
private sector firms—from banks and the finance industry, tech giants, oil and
energy companies, or other firms with direct dependency on politics; private
sector consultants or advisors who held elected office or other positions in
government prior to their corporate career; and interest groups in the
classical sense, represented by lobbyists and their respective boards.
All of these members have an incentive to be a part of a politician’s close
network from which they are free to extract rents as nonmarket revenue.
Firms get them in terms of exclusive procurement contracts, corporations and
interest groups get them in terms of favorable industry-wide or group-wide
legislation and regulation, and campaign donors get them in terms of personal
favors they are free to demand from politicians. This is therefore a network
model of cartelization9 where even though the agents compete against each
other for government favors, they all fully realize the benefits of cooperating
with each other to achieve individualized-level support from the government.
In a codependent system where support and loyalty are traded for
concessions, those linked with the politician, who have a lot to lose from his
or her demise, will make sure he or she stays in power for as long as
possible.
Politicians have strong incentives to form and maintain such networks.
They too can enjoy multiple benefits. They get important campaign
contributions, crucial to their political survival, they can take bribes for
favorable legislation or exclusive procurement contracts, they can get in-kind
benefits (dinners, golf games, sports or theater tickets, various gifts), and can
even benefit after their political careers, earning money by giving speeches at
industry events, or take on high-level executive or board positions in
companies they used to regulate.
However, there are costs associated with elite network membership. For
every agent the most important are reputational costs. If the activities of the
network are uncovered, each agent suffers a cost to his or her reputation even
if the activity is not illegal per se. If the activities are illegal, there is a
potential cost of prison time, which increases the reputational costs before
even engaging in the activity. Each agent also has the cost of effort (which
includes the costs of entry). Being part of an elite network means going to a
lot of social gatherings and activities, thereby spending time to build the
relationship. This may last for several years, even decades, and it may yield
physical costs along with the costs of time and effort. Politicians, in addition
to all of the above, also have the costs of potentially losing an election if any
of their shady activities are uncovered.
The potential benefits from joining an elite network have to outweigh all
the potential costs for each individual agent in order for them to join. This
means that not every person will join an elite network, just the ones who,
according to Becker, value the potential benefits more than all the potential
costs.10 This is further discussed in Chapter 5 presenting a cost-benefit
analysis of elite network membership.

1.1.2. The Role of Institutions

Every political system is based on upholding power. Therefore, the logic of
elite networks should be similar (albeit not identical) across different
political systems. However, the variation in outcomes in curbing this power
differs with respect to how a county’s institutions are defined, which is
conditioned by historical patterns of development and a whole number of
other endogenous factors. This is why we notice different consequences of
elite network behavior in different institutional surroundings. But not
everything is down to institutions.
Consider the puzzle of why voters fail to punish corruption.11 The
institutional argument fails to explain why corruption tends to exhibit high
levels of variation among the highly developed institutionally stable and
inclusive societies. The United States, Japan, France, or Ireland, for
example, exhibit higher rates of corruption than the equally institutionally
well-endowed Scandinavian countries, New Zealand, or Switzerland. The
average gap between the former and the latter group of four countries is 16
points on the Transparency International CPI index for 2020 (Table 1.1). This
is almost the same average gap as between the former group and, for
example, Italy, Greece, Czechia, and Georgia.12 All of the aforementioned
countries fare much better than the low-income countries in terms of
corruption; however, the variation among the first two groups suggests that
institutions are hardly the only explanation.

Table 1.1 All CPI values are taken from Transparency International (2021) and are for the year 2020
Selected Corruption Selected Corruption Selected Corruption
countries (top Perception countries (close Perception countries Perception
ranked; score Index (CPI) to top; score Index (CPI) (medium ranked; Index (CPI)
80–90) 66–77) score 50–60)
New Zealand 88 UK 77 Israel 60
Denmark 88 Austria 76 Cyprus 57
Finland 85 Belgium 76 Latvia 57
Switzerland 85 Iceland 75 Poland 56
Sweden 85 Japan 74 Georgia 56
Norway 84 Ireland 72 Czechia 54
Netherlands 82 France 69 Italy 53
Germany 80 USA 67 Greece 50
Group average 84.6 73.2 55.3
Table 1.2 CPI values taken from Transparency International (2021), * represents autocracies
according to Polity IV (2018)
Selected Corruption Selected Corruption Selected Corruption
countries (low Perception countries (low Perception countries (low Perception
ranked; score Index (CPI) ranked; score Index (CPI) ranked; score Index (CPI)
40–50) 40–50) 38–40)
Slovakia 49 Jordan* 49 India 40
Croatia 47 Cuba* 47 Turkey 40
Hungary 44 Belarus* 47 Colombia 39
Romania 44 Bahrain* 42 Serbia 38
Bulgaria 44 China* 42 Brazil 38
Average 45.6 Average 45.4 Average 39

Political competition and the threat of electoral punishment are obviously

not enough to curb incentives for corruption in all countries. In democracy’s
defense, the average levels of corruption in democratic countries are much
lower than in nondemocratic countries. Electoral competition therefore
certainly does help, but it does not eliminate corruption. In fact, many
democracies have corruption levels equal to or even worse than autocracies
(Table 1.2). For example, the average corruption levels in democratic
Slovakia, Croatia, Hungary, Romania, and Bulgaria (average of 45 points on
the CPI index) have been similar to those in autocratic Jordan, Cuba,
Belarus, Bahrain, and China (same average). Some democracies, like Brazil,
Serbia, or Colombia fare even worse than many autocratic countries. Similar
examples are prevalent, particularly when looking at corruption in
democratic countries of Latin America, all of which have only marginally
lower levels of corruption than most African anocracies or dictatorships.
There is therefore a factor within democracies, even highly developed ones,
that does make corruption possible, permissible, and to some extent
desirable.
In order to account for this variation in political economic outcomes even
across rich democracies I revisit Olson’s idea of organized special interests
with an important addition: interest groups are not necessarily limited to
organized groups in the classical sense (such as labor unions, industry
lobbies, the NRA, AARP, etc.) but also as groups of powerful individuals
that collude together to preserve their status of power. The stronger the links
between them, the more powerful they become. This accumulation of power
among elite networks makes them more successful than any other group in
achieving their goals, which could explain the existence (and persistence) of
corruption and favorable legislation given to certain industries and/or
individuals. Well-defined institutional rules and even a strong legal system
might not be robust to such practices and their consequential outcomes in
every country. In other words, institutions matter, but institutions are not
always fully robust to elite networks.

1.1.3. Elite Theory in Sociology

The definition of elite networks used throughout this book is somewhat
similar to what classical sociology refers to as elite theory. According to
elite theory a very small minority of economic and political elites holds the
majority of power and influence within a society. The origin of power is
derived either from one’s position in the corporate hierarchy or from one’s
position of control over wealth-creating activities. It is through these
positions that elites determine who will hold political power, or at least try
to influence policymaking. Accordingly, a democratic system is often
criticized by elite theorists as incapable to curtail the power of the elites.
Similar to Olson’s logic of group behavior, elites are successful because they
represent a well-organized group with a narrow interest, whereas the
nonelites are disorganized and hence unable to challenge the elites.
The origin of classical elite theory can be found in the works of Max
Weber, Vilfredo Pareto, Gaetano Mosca, and Robert Michels. From Weber
elite theory draws the definitions of power and the three forms of domination
—charismatic, traditional, and rational-legal—through which power
relations are formed within a society.13 From Pareto it determines elite
selection: members of an elite originate from proximity to economic or
political power, which is enabled by political connections of families and
inherited wealth. In other words, if social mobility were unrestricted within
a society, elite members would be drawn from a pool of its most competent
members. However, because of unfair advantages driven by family wealth
and connections, the selection of new elite members is skewed in favor of the
current elite.14 Mosca’s contribution is similar to Olson’s interest group
theory, in that the elite is a well-organized tiny minority, as opposed to an
unorganized majority (“the masses”), and therefore has an advantage in
achieving its own interest. He also discusses the intellectual and moral, in
addition to economic, superiority of elites over the masses.15 Finally,
Michels coined the phrase the “iron law of oligarchy” to define the existence
of ruling elites within any democratic organization, be it the state or the firm.
He discusses the role such elites play within organizations, where they
control both information and resources, therefore enabling them to
concentrate power.16 Elites have been a focus point of many contemporary
research efforts ever since in sociology, economics, and political science.17
What most of them have in common was to understand who the elite is (its
composition), how does one become a member of an elite (its selection), and
more importantly, whether the very existence of elites hampers the idea of
pluralism and democracy itself (its implications).
My approach differs from the aforementioned sociological studies in that I
do not draw implications of elite behavior on the functioning of democracy,18
nor am I focused on explaining within-elite selection. Rather, I am concerned
with showing how elite networks benefit the actors within them—how they
help politicians stay in power, and how they help firms gain a competitive
advantage. Furthermore, I find politicians at least equally important as the
corporate elites. Politicians have the power of creating a legal framework
that benefits certain industries or interest groups, and the power of
redistributing a huge portion of a country’s GDP—its government budget.
The position of political power therefore carries significant impact over the
corporate sector, even when politicians originate from or are appointed by
the corporate sector, as elite theory would assume. Nowhere is this more
obvious than in autocracies, but even in democracies proximity to political
power is a crucial part of what makes membership of an elite network
worthwhile. Finally, I am interested in the consequences of elite network
behavior on the distribution of top incomes through a very specific
mechanism—the effect of political connections, which is a proxy for elite
network membership, on executive salaries.

1.1.4. The Spontaneous Nature of Elite Networks

The pursuit of self-interest is rational, legitimate, and expected within a
political order. When politicians and special interests realize they can both
benefit by colluding with each other, their rational and legitimate response is
to do so. Every citizen within a (democratic) political order has the right and
is encouraged to pursue his or her own interests. Every individual indeed
does so, in almost all cases as a part of a wider group: family, friends,
school, club, society, religious organization, business organization, political
party, etc. The interests can be entirely altruistic where a person gets
satisfaction purely from helping others (e.g., religious organizations or
charities), or they can be entirely selfish where a person gets satisfaction
from furthering his or her own goals, or the goals of those close to them (e.g.,
winning office, getting a better job/salary, etc.). In such an environment it is
natural to expect both cooperation and conflict to occur, with varying rates of
success between groups.
A society, therefore, is a vibrant web of interactions between a multitude
of agents organized through various groups all promoting their own interests,
whether selfish or altruistic. Some are more some are less successful at
doing so, which means that some groups will over time acquire more power
and influence than others. People with wealth and power in democracies
arise as a consequence of such a dynamic exchange, and once they reach
wealth and power, they have every incentive to preserve it. This is an
evolutionary behavioral trait of humans: being well off compared to those
around creates an incentive to maintain this status. Being worse off creates an
incentive for change.
If everyone in a society is equally well off or worse off, people will lack
behavioral incentives to drive themselves into action. This is what explains
the failures of communism in countries like Mao’s China, Pol Pot’s
Cambodia, or North Korea, where equal misery among the population
reduces incentives to aspire to anything better, thus retarding economic
development. When everyone in a society is equally miserable, being
miserable is taken as a natural state of affairs. When one knows he or she is
miserable but there exist a wealthy few (such as monarchs, nobles, or
contemporary wealthy elites) then there is a strong incentive to change such a
social order. This is what triggers revolutions—inequality eventually reaches
a boiling point above which people react to a sense of injustice.19
The contemporary divide between the rich and the middle classes is a
natural consequence of a society in which individuals and groups fight for
their own interests. This “fight” is a euphemism. The fight itself is what
Adam Smith described as a persistent interaction between self-interested
individuals who will all, as if being led by an invisible hand, act to promote
the collective interest.20
One thing is missing from Smith’s quintessential contribution: the fact that
success and hence power varies between groups. Successful groups will be
able to skew the distribution of resources toward themselves. Successful
groups, with a greater stake in maintaining their position of power, will have
a greater incentive to shape systemic rules and incentives. A good example
of this is the elite-competition theory of democratization by Ansell and
Samuels. They argue that democratization did not commence as a
consequence of fear from uprising by the unorganized and dispersed poor
who wanted political rights (as suggested by comparative political theory
explaining the origins of democracy), but rather, building on Olson’s logic,
from the well-organized and concentrated wealthy who lacked political
representation and feared expropriation of their newly acquired wealth by
the state. Successful groups emerged to form a new elite.21
Have the elites in some way conspired to produce such outcomes? I reject
the premise of a conspiracy theory.22 Elite behavior is not due to some grand
intelligent design. Each self-interested agent or group of agents formulates
networks with others and acts within them to further their interest. Be it
businesses, civil society groups, or the government itself. They all, albeit
different, behave exactly the same way. They formulate clusters and interact
to determine what is best for each of them. Each group is prepared to
vigorously defend its actions under the justification of protecting the interests
of its members and/or their ideological worldview. No group will ever
consider that the furthering of its interest will in any way harm the rest of
society. Quite the opposite actually.
This is why there can be no conspiracy and no grand design, just random
sets of clusters that are highly connected and interdependent and have a
strong incentive to preserve their interest. There is no “enemy” in the
classical sense of that word. People with power are, after all, only
temporary. There is a persistent flux and dynamism between those who
currently hold power, those who held it 20 years ago, and those who will
hold it in 20 years’ time. However, in each case, no matter who holds power
and who the elite is, they will always express the same behavioral pattern—
self-preservation.
The formation of elite networks within a country is therefore entirely
spontaneous, serving to promote the narrow interests of its members, and
limited in most cases geographically, around the centers of money and power.
Figure 1.2 shows the geographical clustering of US and global Fortune 500
companies, where 85% of the top 500 global companies are located in the
biggest urban centers in only nine countries. In the United States the
distribution is geographically more even, however the urban centers on the
East Coast, Silicon Valley, Chicago, and Texas still feature a heavy
concentration of industry giants.
Figure 1.2 Geographical clustering of Fortune 500 companies in the United States (upper panel) and
Global Fortune 500 (lower panel). The clustering within the United States is tied to urban centers (the
East Coast corridor from Boston to Virginia has about 25% of all Fortune 500 companies, followed by
the Silicon Valley, Chicago, and Dallas and Houston in Texas, each with about 6% to 7%). Globally
three areas dominate in the clustering of the biggest 500 global companies: East Asia (36%; China,
Japan, Korea), United States (27%), and Western Europe (22%; France, Germany, United Kingdom,
Switzerland, Netherlands). Source of data: Visualize the Fortune 500, available at: https://fortune.com/fr
anchise-list-page/visualize-the-fortune-500-2022/.
An elite network is essentially a social network characterized by high levels
of positive assortativity—the tendency of highly connected and powerful
individuals to be closely connected with other highly connected and
powerful individuals.23 Highly connected individuals tend to cluster with
each other so that they maximize their influence across the broadest segment
of the population. For example, Fortune 500 CEOs, sports and entertainment
agents, or venture capitalists all have a strong interest (and it is part of their
job description) in being connected to a large number of other highly
connected individuals. For them the mere volume of individual connections
is irrelevant as long as the network as a whole is important and serves a
purpose. The same logic applies to politicians who, by the very definition of
their jobs, become connected to a wide network of powerful and well-
connected stakeholders, whether locally or nationally.
This makes every elite network in a country highly topocratic, meaning
that the average compensation of an individual depends on how connected
they are, and how central they are within the network. A topocratic network
is the opposite of a meritocratic network—it matters more who you know
than what you know. According to Borondo, Borondo, Rodriguez-Sickert,
and Hidalgo, if a country is dominated by topocratic networks it is more
likely to have higher levels of economic inequality.24 The logic is simple: the
majority of people in a country are poorly connected to one another (they do
not know many people outside their everyday environment) while a very
small number of individuals in key positions of power are highly connected,
in most cases to other highly connected individuals in powerful occupations.
This is the very essence of an elite network. One notable advantage of these
connections is access to privileged information on various opportunities (for
example, job listings of top management positions, business opportunities
such as private tenders, or valid stock tips) which are usually limited to a
very narrow social group of trusted individuals. One obvious consequence is
an increase in informational asymmetry, which skews the distribution of
wealth-gaining activities toward a narrow group of highly connected
individuals.

1.2. Visualizing Elite Networks

In order to understand the topocratic nature of elite networks, it is perhaps
best to visualize a few of the most notable examples. The obvious place to
start is the revolving door between politics and finance, focusing specifically
on individuals who achieved high levels of centrality within their networks
by building tight relationships in both the corporate and the political world.
These are typically individuals with a high number of connections (high
network degree), and high levels of betweenness centrality, meaning they
stand as a central node between two or more distant groups providing a
connection between them. Their position is valuable precisely because of
their level of connections and network centrality. Network theory recognizes
such individuals as superhubs.25
In order to draw networks of a few selected superhubs, I use a unique
database of over one million individual-level corporate, political, and public
office connections in the United States.26 This database was the cornerstone
for the empirical findings presented in Chapter 4 of this book. It includes
connections between corporate executives and people sitting on corporate
boards of all publicly listed companies in the United States. In addition to
corporate executives, the database also lists all politicians or academics
sitting on various corporate boards, as well as public officials in higher
office positions. The database allows the user to search across previous
careers, education, or membership in various organizations (business clubs,
nonprofits, charities, church groups, etc.) as a way to link different
individuals and establish the strength of one’s connection to other powerful
individuals.
When drawing such networks, there are always a few people that stand
out—those with a high number of connections (high degree), and those in the
center of the network, connecting individuals through various links (high
betweenness centrality). The graphs are drawn so as to include only first-
degree connections27 for the person of interest, and we see all the
interconnections between those connected to that person, the central node.
Each node in the figure represents one person, and the lines are
connections/links between them. Individuals with high levels of betweenness
centrality will be at the center for a lot of groups/clusters that surround them.
They will typically not be part of a cluster, but will stand in the middle
between them and connect different clusters together.
The first example is an embodiment of a superhub drawing connections
between Wall Street and public office, and one of the most powerful and
controversial figures in finance in the 1990s and 2000s, former US Treasury
Secretary Robert Rubin. Prior to becoming President Clinton’s treasury
secretary in 1995, he worked at Goldman Sachs for 26 years, eventually
becoming cochairman, before moving on to public service. As treasury
secretary he carried out the infamous repeal of the Glass-Steagall Act, which
used to separate investment and commercial banking, and oversaw a number
of loosened financial regulations concerning derivatives.28 Many have
blamed these policies in particular for the calamity that ensued in 2008. After
his tenure at the Treasury, he moved on to Citigroup in various positions, but
controversially resigned in January 2009, at the height of the crisis, while
taking $17 million in cash and $33 million in stock options, receiving in total
$126 million during his time at Citigroup. He left when the bank was
virtually insolvent, having to be bailed out by US taxpayers.29 He also came
under investigation in 2001, when he used his former connections at the
Treasury asking if they could convince credit rating agencies not to
downgrade Enron’s corporate debt, of which Citigroup was a large holder.
He was cleared of any conflict of interest in that case.30
Rubin, therefore, is a man who held strong ties to Wall Street elites and
obviously carried significant political clout as the man who spearheaded
President Clinton’s very successful economic agenda. He was a superhub of
an elite network, acting as an important connector between the political
establishment of the ruling Democratic party and the initially skeptical
business community. Rubin had no trouble using the power granted to him by
his network centrality to promote his interests, both while in office and
especially after he came back to Wall Street.
His network, drawn in Figure 1.3, clearly shows this central position
connecting a total of six different groups, coalesced into clusters. Each
cluster corresponds to a different part of his life and career. The majority of
people in this network are either from politics or banking, followed by other
corporate executives and wealthy investors. For example, the red cluster in
the far upper corner are mostly people he knew from banking and business
(connected to him throughout his career either at Goldman or Citigroup). The
light blue group furthest down are people connected via Blair Effron, a
cofounder of Centerview Partners, an investment banking firm. Then there in
the pink cluster (up, right) are people Rubin met through politics like the
former Clinton advisor and White House communications director under both
Reagan and Ford, David Gergen, or Peter Orszag, another individual who
made a transition from public office (during Clinton and Obama
administrations) first into Citigroup (just like Rubin), and then becoming the
CEO of Lazard. Also in the same cluster is the former President Bill Clinton
himself, along with several other high-ranking politicians.

Figure 1.3 Network of Robert Rubin (big black middle node), former US Treasury Secretary and
former co-chairman of Goldman Sachs.
 In the green cluster (down, right) are people from the academia that Rubin
also encountered through politics and possibly the Council on Foreign
Relations, like Glen Hutchins (Silver Lake, also serving in the Clinton
administration), Columbia professor Lynn Thoman (who is the big connector
between the green and the dark blue clusters (down, left)—featuring lesser-
known businessmen and investors), Sheila Burke (former Dean of Harvard
Kennedy School), and so on. Then there are people like Rubin’s successor at
the Treasury, Larry Summers, also in the middle of connecting a few clusters
between the corporate world, academia, and politics. Finally, in the orange
cluster (up, left) are other notable corporate CEOs and Wall Street
executives that complete the deep strength of his network.
Rubin finished his career as the chairman of the Council on Foreign
Relations for 10 years before retiring in 2017. The Council is a nonpartisan
think tank that, among other things, publishes the journal Foreign Affairs, and
within its membership gathers many senior politicians, former secretaries of
state, diplomats, corporate executives, bankers, and media figures. More than
a suitable end-of-career position for a man with such network centrality. In
fact, the Council itself represents a well-established location for an elite
network hangout. It is a place where network ties between powerful
individuals are established and deepened. The Council is obviously not the
only such place, nor is it the one that necessarily attracts the most powerful
superhubs (like the Davos World Economic Forum), but it is a place where
networks are broadened and interests get aligned. Rubin’s superhub status
stands at the center of such an elite network.
The 2008 crisis forced Rubin out of banking, albeit with a hefty
compensation, but it set the stage for three other individuals whose elite
network superhub status was essential in curbing the September–October
post-Lehman panic. Henry Paulson, the treasury secretary under President
Bush, and prior to that CEO of Goldman Sachs; Ben Bernanke, the Fed
Chairman; and Tim Geithner, the president of the New York Fed, and the first
treasury secretary under President Obama.
The three of them conceived and carried out government bailouts of major
US banks during the most turbulent period for the US financial industry since
the Great Depression. The crux of this episode, arguably quite successful in
restoring stability and mitigating further panic, were regular daily formal and
informal meetings and phone calls held between Paulson, Geithner, and the
chief executives of the nine biggest banks in the country.31 The goal was to
figure out the best response strategy to the ongoing post-Lehman panic. The
response came in the form of the Troubled Asset Relief Program (TARP), a
bailout package that diverted over $180bn taxpayer funds to the nine biggest
banks that were involved, at least informally, in drafting the package. The
people in charge of the big banks had deep connections to the two key
regulators who were drafting the TARP bill. Paulson used to be CEO of
Goldman Sachs prior to becoming treasury secretary, while Geithner’s
position as the president of the New York Fed is chosen by a board
containing the chief executives of all the biggest banks in the city.
This is another typical example of an elite network, one that ties together
key public officials with the most powerful corporate executives in the
process of drafting regulation that significantly affects those very same
corporate executives and their compensations (primarily through bonus
schemes). It is an elite network outcome that directly affects top incomes of
politically connected executives, thus adding to income inequality. Most
importantly, the elite network relationship in this case is not illegal nor
illegitimate. It is a spontaneous self-preservation instinct that guides
behavior of elite network members to pursue their goals. During the biggest
financial panic of their lives, it was hardly surprising to see chief executives
grabbing any opportunity to persuade policymakers, members of their own
elite network, to help them.
Figure 1.4 shows Paulson’s network. His network, just like those of
Geithner and Bernanke, was drawn by excluding the other two in order to
avoid congestion in the graph. Paulson’s network is less dense and less
diverse than Rubin’s from Figure 1.3, but it does paint a very accurate image
of Paulson’s importance and centrality. The closest to him, for example, is
another big connector (the big green node, immediately above him), Muneer
Satter, his former colleague from Goldman, and founder of Satter Investment
Management. There are also academics (red clusters, sparsely connected, to
the right) like Anne Krueger (famous for her 1974 paper on rent-seeking,
who later worked at the World Bank and the IMF), or Chicago economics
professor Michael Greenstone.
Figure 1.4 Network of Henry Paulson (big black middle node), former US Treasury Secretary, and
former CEO of Goldman Sachs.

In the more dispersed clusters (lower, right) are people from the
corporate world like former American Express CEO Ken Chenault, or
Disney CEO Bob Iger, but also many academics, journalists, and politicians
Paulson encountered through his Treasury tenure. They were all connected to
him through his tenure in politics, but are in separate clusters because people
from the corporate world are typically not well connected to journalists or
academics. Paulson was the connector. The green cluster (upper, right)
contains individuals from the banking world, ranging from his former firm
Goldman Sachs to executives from JP Morgan, Morgan Stanley, Citigroup,
Bank of America, etc. In short, all the executives32 he had regular contact
with during the banking crisis. Note the high clustering coefficient of this
group, suggesting a typical elite network pattern of interconnectedness of
people working in big banks.
Finally, the blue and orange clusters (left), both closely interconnected
into one single cluster,33 contain individuals from the academia and the NGO
sector who work on environmental issues concerning climate change. This is
because Paulson, after his public office career, set up the Paulson Institute
with a goal of advocating cleaner environment initiatives and fighting climate
change. He is also engaged in a number of similar environmental activities
and NGOs, from which he draws the rest of the cluster.
Figure 1.5 shows Geithner’s network. Geithner was the subject of an
interesting academic research paper34 that presented the social connections
during a crisis hypothesis. The idea is that every person of power has a
narrow social network on which they rely during high-stress episodes when
crucial decisions need to be made. Geithner’s connections to the industry
were so important that the stock price of every firm connected to him went up
and delivered abnormal returns immediately after he was nominated by
President-elect Obama. Geithner’s position of treasury secretary during the
Obama administration was very similar to Rubin’s appointment during
Clinton—they both sent a comforting signal to the industry that their elite
network member has the highest level of decision-making power. It was
reassuring for the industry that the same person they held deep ties to during
the previous administration, the person whom they’ve aided in drafting the
TARP proposal, is now at an even greater position of power to potentially
benefit them.
This is obvious once looking at Geithner’s network. It resembles that of
Bob Rubin, in that it has seven different clusters all connected through him as
the central node. Interestingly, the second-biggest node in Geithner’s network
(the big red node close to the dark blue cluster, in the middle, slightly to the
right) is Jack Lew, former lawyer and congressional staffer, who became
Geithner’s successor as treasury secretary, after which he left to become the
COO of Citigroup.
Geithner was, throughout his career, much more involved with public
service and politics than both Paulson and Rubin, which his network reveals.
It is almost double the size of Rubin’s and almost three times the size of
Paulson’s. He joined Wall Street after his public office tenure, just like Lew,
so it makes sense that their networks will be slightly different from Rubin’s
and Paulson’s, despite all three being good examples of elite network
clusters. A lot of the same people from banking that were connected to
Paulson are also connected to Geithner, mainly through the green (upper) and
red clusters (right, and middle). Incidentally, the upper green cluster also
features all individuals working at Warburg Pincus, the private equity firm
where Geithner was appointed as CEO after his public office career.
Geithner was the key connector between Warburg Pincus and JP Morgan, for
example, leading to a multibillion-dollar investment from JP Morgan into
Warburg in 2016.35 All of these banking connections are present in the
network.
Figure 1.5 Network of Tim Geithner (big black middle node), former US Treasury Secretary and
former president of the New York Fed.

The middle red clusters, scattered all around, contain people Geithner met
through his time in office; on one hand people from the Obama
administration, like the aforementioned Lew, former chiefs of staff, and other
cabinet members, to people from the World Bank, European Bank for
Reconstruction and Development, or the IMF, like David Lipton, to foreign
ministers of finance, like Vitor Gaspar from Portugal, Simeon Djankov from
Bulgaria, Donald Kaberuka from Rwanda, etc. Each group is a cluster within
itself; the IMF and World Bank are one, the European finance ministers are
another, African and Asian finance ministers yet another.
Geithner also draws connections through his membership in the Council
on Foreign Relations (CFR), the aforementioned elite network hangout.
These belong to the blue cluster (far left) and they include some notable
names like three former secretaries of state, Condoleezza Rice, Madeleine
Albright, and even Henry Kissinger, but also other notable diplomats, former
bankers from JP Morgan, Goldman Sachs, Citigroup, Wells Fargo, or senior
public officials such as former World Bank president James Wolfensohn.
Note also that the far-left cluster is, via Geithner and two other nodes,
connected to the pink cluster (lower left) containing mainly former
politicians, most notably Barack Obama and Hillary Clinton, and many
public officials that served in the Obama administration (chiefs of staff, press
secretaries, some cabinet members, and so on).
The key connectors here, between the green (upper), purple (lower, left),
and red clusters (middle), besides obviously the central node Geithner, are
the billionaire David Rubenstein (chairman of the CFR and member of many
boards, a true networker), Obama’s deputy chief of staff Mona Sutphen
(another public servant who switched public office for a private equity firm
and later ended up at UBS), Sharon Percy Rockefeller, the former first lady
of Virginia, and active member of the Bilderberg Group, and the
aforementioned former IMF director David Lipton. The yellow cluster
(lower, right) are all current or former employees of the US Treasury, some
of whom moved on to other careers in finance, the corporate sector, or
diplomacy. Note that the big red node, Jack Lew, is connected to the very
same people after succeeding Geithner.
Geithner, therefore, successfully connects several elite networks: the CFR
network, the private equity and banker network, the network of foreign
ministers of finance, and the network of former or current public officials and
high-ranking politicians. He is the embodiment of an elite network member
with high betweenness centrality, and hence extreme importance. No wonder
his presence was crucial during the height of the 2008 panic.
Ben Bernanke, the last member of the trio, has an even larger network than
all the three former Treasury Secretaries, depicted in Figure 1.6.
Figure 1.6 Network of Ben Bernanke (big black middle node), former Fed Chairman.

However, the majority of his network, the big blue cluster in the upper right
corner, consists of academics, given that he came to the Fed from the position
of a tenured Princeton professor. After the Fed, he deepened his academic
connections through his position as a fellow at Brookings Institution. The
smaller pink nodes attached to the blue clusters are also academics, but
academics Bernanke met outside Princeton or Brookings. The scattered pink
connections (far right, and middle, around the center) contain people from the
IMF, the World Bank, and many other central bankers across the world. Some
of these nodes include people like Stanley Fisher, another academic
economist who served as a Federal Reserve vice chair and a governor of the
Bank of Israel, and Anne Krueger, an academic economist taking positions at
the IMF and the World Bank. An interesting connection is the big blue node
in front of the red nodes (first big node next to the center)—this is Bernanke’s
successor and Biden’s treasury secretary, Janet Yellen. She too has numerous
links between the academic blue clusters and the red cluster (down, right)
which are mostly former politicians and public officials.
Bernanke’s other connections are linked to his post-Fed advisory
positions at Pimco and Citadel. The Pimco cluster is green (down, far left),
featuring two interesting connectors. One is former European Central Bank
chairman Jean-Claude Trichet, who took a similar position to Bernanke’s at
Pimco following the end of his term (Pimco, apparently, enjoys appointing
former central bank governors), and the other is the Nobel laurate behavioral
economist Richard Thaler. He links Pimco to the blue academic cluster,
while Trichet links it mostly to the political red cluster. Bernanke links them
to both.
Finally, the yellow cluster (up, left) are people from Citadel, the market
maker where Bernanke serves as an advisor. The biggest node in that group,
connecting the yellow cluster with the red and pink ones in the middle, is
Citadel’s founder Ken Griffin. He too sits at a very interesting intersection
between politics, business, and public office.
Next, we divert our attention to two very powerful figures in the financial
world, both considered to be important networking nodes with high levels of
betweenness centrality, and whose networks are characterized with high
levels of assortativity. The first is JP Morgan CEO, Jamie Dimon, often
dubbed the public’s favorite Wall Street banker, while the second is one of
the most famous investors of all time, George Soros.
These two are interesting as they, unlike the previous four, still yielded a
powerful influence in finance and investing at the time their networks were
drawn (latest data from 2019).
Figure 1.7 Networks of Jamie Dimon (upper), and George Soros (lower).

Their networks, however, differ almost dramatically (Figure 1.7). Dimon’s

network is huge, he is one of the most connected individuals in the entire
database. Soros on the other hand, while still a highly connected and
important node, has a much less dense network and is connected to only one-
fifth of the corporate bosses and politicians that Dimon is connected to. This
is an interesting observation given that these two represent alpha
personalities that attract even the most powerful elite network members at
gatherings like the CFR or the Davos forum (as eloquently presented in Navi
di’s Superhubs). Finally, unlike the aforementioned, who are no longer in the
same position of power (although they still carry a lot of influence), Dimon
and Soros still possess real power; the first through his long-lasting position
as the CEO of America’s biggest bank, and the second as an intriguing
world-famous billionaire investor, notorious for being called “the man who
broke the Bank of England,” but also an often-used scapegoat for many
conservative politicians who like to emphasize his links to the Clinton
family, or his promotion of a liberal agenda (which are the basis of frequent
antisemitic attacks on him personally, especially in his native Hungary).
Despite their similarity, Soros seems much less connected to the US
corporate and political world than Dimon. In fact, most of Soros’s
connections are people working for his foundations: academics (like Lord
Robert Skidelsky or Hans-Werner Sinn), notable economists (like Financial
Times’s John Kay or former Financial Services Authority chairman Lord
Adair Turner), and one former central banker, Paul Volcker. There are very
few politicians (the Clintons, former New York mayor and billionaire Mike
Bloomberg, and a few ambassadors like Susan Rice) and only a handful of
investors and bankers (most working for some of his funds). His network is
however more international, spanning from the United Kingdom and Europe
to the Middle East (Emirates and Qatar) and Southeast Asia.
Dimon, on the other hand, is connected to a huge number of former or
active corporate executives (the red clusters, to the left), and an even larger
number of people in banking and finance (the blue clusters, to the right).
Politicians and public officials are scattered in the green and pink clusters
(lower left corner). His network contains some of the same aforementioned
names, including former treasury secretaries Geithner, Lew, or Summers,
central bank governor Bernanke, and every big bank CEO who held regular
meetings with Paulson and Geithner during the September 2008 panic (Lloyd
Blankefin of Goldman Sachs, Ken Lewis of Bank of America, Vikram Pandit
of Citigroup, the controversial John Thain of Merrill Lynch, and so on).
Dimon’s network reaches much broader than finance. He is connected to
many notable corporate executives, like the long-lasting General Electric
CEO Jack Welch, Microsoft CEO Steve Ballmer, Exxon CEO Rex Tillerson
(who later became Trump’s first secretary of state), in addition to some of the
wealthiest men in the world like Amazon’s Jeff Bezos, LVMH’s Bernard
Arnault, or Dell’s Michael Dell. The network does not stop there, it
transcends into politics to include former president Barack Obama and
former secretary of state Condoleezza Rice in addition to many senators,
congressmen, ambassadors, and a host of other powerful people like lawyer
Robert Shapiro, or James Murdoch, former CEO of 21st Century Fox and the
son of media mogul Rupert Murdoch.
With a powerful network like this one, Dimon is obviously proving his
worth to JP Morgan. A central elite network node, a corporate executive
with links to many people at key decision-making positions, who is able to
use his networking power to deliver successful outcomes to his firm. For this
he is consistently rewarded, to a point where he is among the few corporate
executives that have become billionaires.36 It is easy to see how this case in
particular exacerbates the income inequality issue at the very top of the
income distribution. Elite network mechanism at work. Unintended, surely,
but highly effective.
 The only person that can be compared to Dimon in terms of networking
prowess and who still yields considerable business power is Larry Fink,
CEO and founder of the biggest global investment fund, BlackRock. Fink runs
a company with $9 trillion assets under management, which holds equity in
over 5,000 of the largest US and global publicly listed companies.37 He
possesses considerable power in terms of influencing management decisions
of companies in which BlackRock holds equity.

Figure 1.8 Network of Larry Fink (big black middle node), founder and CEO of BlackRock.

As Figure 1.8 shows, Fink’s network is very similar to Dimon’s. High

degree, huge betweenness centrality of the central node, and high level of
assortativity. In fact, Fink is connected to almost all of the same people
Dimon is connected to, including Dimon himself (the big green node, close to
the center, with high betweenness centrality): Paulson, Geithner, Welch,
Ballmer, Tillerson, Bezos, the Murdoch family, Moynihan, Blankfein, and a
number of other decision-makers in banking, the corporate world, and
politics. In fact, Fink’s exposure to politics is even greater than Dimon’s due
to his board membership at the Council on Foreign Relations and the World
Economic Forum. He is also on the board of the Robin Hood Foundation, the
most famous New York charity organization, a networking hub for a myriad
of investors, bankers, and politicians.
It is not surprising that Dimon’s and Fink’s networks are so similar. They
both possess highly assortative networks, each clustering around the same
powerful people, suggesting a clear elite networking pattern that makes such
networks highly topocratic. Recall from the previous section that a system is
topocratic if the compensation and power available to an individual is
determined primarily by their position in a network. This was true for all the
aforementioned public officials as well: the 2008 crisis trio and Rubin. From
these examples it is easy to see how topocratic networks encourage the
dissemination of privileged information, exchange of favors, and soliciting
advice in times of great uncertainty and adversity (like during the 2008
crisis).
However, despite such implications, the existence of elite networks is a
natural occurrence in any society. People in positions of power, whether
corporate or political, will always be drawn to other similar people in
power. This may often yield positive consequences for societal development.
Elites can use their power to deliver beneficial outcomes and even provide
for certain public goods (through the gift exchange principle—a good
example is the Robin Hood Foundation). The problem is not with the
motivation for entry nor with the existence or assortativity of elite networks.
The problem is the extent to which elite network membership allows its
members to capture power and bend rules in their favor. This is the outcome
that implicates wealth concentration and high inequality, and this is the
outcome that needs to be prevented.
The logic of elite network formation will be further examined in Part II of
the book, particularly through Chapter 7, which examines corporate cultural
capture and superhub links between finance and politics. It explains how and
why personal relationships and connections between the central nodes in
politics, public office, and the corporate world are all but inevitable. It also
shows empirical evidence of how connections to politicians and public
officials made an important difference in the allocation of bank bailouts
during the 2008 financial crisis.

1.3. Putting Elite Networks on the Map of Political Interactio

ns
In order to fully understand elite network behaviors and their consequential
outcomes, we should also place them in the correct context of a broader
pattern of interest group behavior. According to Olson, the more narrowly
defined groups are the ones with the best ability to solve the collective action
problem, and given their narrow scope of interest, they are more likely to
exhibit stronger preferences and high salience for the issue at hand. This
concentration of preferences coupled with their ability to eliminate the free
rider problem will, over time, give them enough resources to gain
considerable power in pursuing their interests. We can derive two factors
that determine the relative strength, and hence success, of an organized
group: (1) salience (s) of the group’s preferences toward a given set of
socioeconomic and political issues—this determines strength of members’
preferences and their ability to solve the collective action problem; and (2)
the amount of resources, that is, money and power (p) the group has at their
disposal—this is required in order to advocate and fight for the collective
interest of the members.
Salience is defined over a set of socioeconomic and political issues
instead of just for a single issue. Every group has high salience for at least
one issue. They would not form a group in the first place if there was no
issue over which its members’ preferences are aligned. The set of
socioeconomic and political issues represents the cause every group is
fighting for. The causes range from altruistic, where the group satisfies their
interest by helping others, to purely selfish, where the group cares only about
promoting its members’ personal goals. A member of an elite network cares
very strongly about preserving its status and will use any argument (like
building a better society) to justify their cause. Salience can therefore be best
expressed as a measure of strength of the members’ preferences.
Money and power are used interchangeably as a single category. Money
refers simply to the amount of funds a group has at its disposal. Power
supplements the money category. For example, unions in the 1960s in
Western Europe and the United States did have a lot of resources, but the
primary reason for their success was not money, but the bargaining power
they held. Churches in some countries have a lot of resources, but in others
their access to money is limited. In each case, however, they carry real
power over a large group of churchgoers. An elected political in office has
real power over the distribution of the budget. In his case, power leads to
money. A dictator has even more than that. In addition to distributing
resources, the dictator also makes choices over life or death; hence his
power is maximized and uncorrelated to money.
Based on the realization of these two factors we can draw a two-
dimensional spectrum of the category of groups we find in a society. Each
category is broadly defined to include a number of individual interest groups
that best fit the categorical definition. For example, categories like NGOs,
church organizations, lobby groups, or labor unions include all possible
individual interest groups which will obviously differ between each other
with respect to their level of resources and their relative power. This is why
I only focus on categories as opposed to spatially defining case examples of
individual groups. The two-dimensional spectrum is drawn on Figure 1.9.
Note that each point on Figure 1.9 is the hypothesized average value of s
and p for each group, meaning that for each point there is both a horizontal
and a vertical distribution within which each individual group is located.
Think of each point as the intersection of mean values of the distributions for
salience and money/power for each interest group category. For example,
some sects are certainly more resourceful (or even much less salient) than
others, but on average their clustering in terms of money/power is on the
lower right end of the spectrum. Also, some lobby groups and unions are
more powerful than others, but on average they are never as powerful as an
elite network (provided that they operate outside of it).
Figure 1.9 Two-dimensional spectrum of interest group categories by salience (s) and money/power
(p). Elite networks are part of the first quadrant, but being positioned in the upper right quadrant does
not imply elite network status.

There are four possible spatial positions, each corresponding to one quadrant
on the figure:
If, the group is very powerful and is able to obtain considerable
resources, while its members possess strong lexicographic preferences over
their preferred set of outcomes (such as maintaining their relative level of
power). In this first quadrant (upper right) we would find typical examples of
elite networks as defined in the book: a collusion of political and corporate
elites in democracies. In dictatorships this elite network is the group that
surrounds the dictator, usually referred to as his cronies. The dictator’s elite
network is identical to the ones present in premodern times, represented by
kings and nobility.
This first quadrant also includes political parties and various lobbyist
organizations which are not always direct members of political elite
networks but are close enough to render considerable influence. The majority
of political party members in democracies cannot be considered as part of
elite networks (regular members, volunteers, and activists), but the few that
hold elected office are elite network members and therefore belong in a
different category. Similarly, if a particular lobbyist is a member of an elite
network, then he or she no longer belongs in the category of lobbyists. An
example of a lobby group that is not necessarily part of an elite network
would be the AARP. The NRA is an example of the latter, as it exhibits
significant influence over politicians via campaign donations. A similar level
of influence was held by the labor unions in the West in the 1960s and 1970s.
They had a large and well-organized membership with strong preferences in
addition to considerable resources, which made them a powerful player on
the political spectrum. Their modern counterparts however belong in the
lower quadrant—they maintain the same relative level of salience (they still
fight strongly for their issues) but they do not possess nearly as much
bargaining power as they did in the 1960s.
If , the group is less resourceful but still contains a considerable
amount of salience toward a set of issues they find important. These groups
belong in the fourth quadrant. Typical examples include religious
organizations, various NGOs and modern-day unions, and an extreme version
—various sects and cults which on average do not carry any de facto power
(except over its members) but do have considerable salience over their
beliefs on what a society should look like. A sect is a good example of a
group whose members possess very strong preferences over a defined set of
issues, but outside this very narrow group they have virtually no influence at
all. If a sect increases its resources enabling it to turn into a proper religious
organization (like scientology), their spatial position changes and they move
up within the category of religious organizations. NGOs are the only category
for which I define two types: the more aggressive ones like Greenpeace or
antiabortion activists, and the more passive ones like various charity
organizations or advocacy groups.
If , the group is wealthy (or powerful) but its members’
preferences on various political and socioeconomic issues are not as strong
as with other groups. They usually have a very small number of things they
care strongly about and, if necessary, they might use their money/power to
influence it. These include the idle rich like jetsetters (typically with
inherited wealth) and to some extent yuppies (in the 1980s) and social media
influencers (nowadays) whose main concern is their lifestyle, rather than
societal issues. The military, on the other hand, is a very hierarchical and
strongly aligned group and should, by every rationale, always belong in the
first quadrant. In dictatorships they do, in fact, belong there—as members of
the dictator’s power-holding coalition. But in democracies, without exposure
to war, the military usually does not get involved in current affairs. The
strength of their preferences, their salience, is still very strong, but their
issues are limited, which is why under normal conditions they belong in the
second quadrant. The military is the best example of a group that can shift
very quickly between quadrants (from the second to the first), primarily
because of the relative resources that they possess. If a war occurs, they are
immediately placed within the first quadrant.
Finally, if , the group is typically too dispersed and unorganized to
solve the free rider problem of its members which is why very often the
group is never able to successfully organize to promote its interest. The best
examples are Olson’s definitions of dispersed groups such as consumers or
the unemployed. They are too diverse and too geographically dispersed to be
able to organize and thus act in their common interest. This makes both the
consumers and the unemployed classical price-takers. The strength of their
preferences may be strong, but they are unwilling or unable to solve the
collective action problem. When a consumer group, for example, becomes
organized in order to demand better quality service or better regulation of a
given industry, they then switch to the fourth quadrant, and enter the
distribution space of type-2 NGOs. If they feel really strongly about an issue
and are able to generate more resources, they join the distribution space of a
type-1 NGO or even a lobby organization or political party.
Even though Figure 1.9 represents static relationships between categories,
the behavior of individual groups is always dynamic. The relative position of
a group on the spectrum may change. For example, politicians are members
of elite networks when and if they are in power. When they are not in power,
or are not even expected to be in power, their position on the spectrum will
alter, and will move most likely to the fourth quadrant (when in opposition
but with a high probability to win office at one point), or very low in the
fourth and converging to the third quadrant (when in opposition but with a
very low probability to win office at any point).
The given two-dimensional space does not represent individual fixed
points where we would locate each and every example of an interest group
we can find. It represents the mean values that individual groups converge to
or diverge from. The main point of Figure 1.9 is to showcase the spatial
position of an interest group necessary to successfully advocate one’s
interest. Individual groups within each category (NGOs, unions, religious
organizations, lobbyists, political parties) will position themselves
somewhere within the spatial intersection of the two distributions for each
category, and may switch categories depending on their relative exposure to
resources or the discipline of their membership. In order to be fully
successful in promoting their members’ interests, a group should aim to be
located in the first quadrant. The level of success in the fourth quadrant
depends on how close they are to the first, or in other words, on the number
of resources they have. Members of the second quadrant, because they are
resourceful, can easily switch to the first if they stumble on an issue of high
enough salience that will trigger their membership (e.g., a war or budget cuts
for the military, or an issue a group of influencers feels strongly enough to
promote and change). However, members of the third quadrant will have the
hardest time shifting closer to the first as they face two main obstacles—(1)
lack of resources and (2) lack of incentive to organize.

1.4. Quantifying Elite Network Outcomes

Empirical efforts at recognizing who is and who is not a member of an elite
group have usually been limited to occupational studies where all leaders of
business, political, or military organizations have been classified as the elite.
38 This is helpful in understanding the network of connections between
powerful individuals, but is not enough to tie their connections to a particular
set of outcomes.
This book is primarily focused on outcomes that are supposed to result
from an elite network–type of relationship, rather than listing and analyzing
its individual members and their connections. The relationship that leads to
an outcome is hidden (deals done behind closed doors), but the outcome
itself is visible, as are the connections between powerful individuals. For
example, a politician whose district is riven with fraudulent procurement
contracts keeps winning elections and stays in power for a long period of
time. The same politician has a carefully selected group of local businessmen
and power brokers on his side, which provide him with the necessary funds
and votes in exchange for favorable contracts with the government.
 A symmetric example is a firm whose top management has a clear
connection to politics and receives a beneficial treatment from the
government, where the decision is made by the very same politicians to
whom they are connected. To bind these outcomes together I construct an
indicator of elite membership by looking at how certain top executives use
their political connections and their relative position within a social network
in order to drive up their compensation packages. Essentially there is no
precise way of measuring an exact elite network relationship, mostly because
their interactions are hidden from the general public, but it is possible to
apply a number of approximations by making inferences from direct
outcomes that have the highest probability to signal an elite network–type of
relationship.
As defined earlier, the reason why someone would enter into an elite
network is to preserve their position of power. All elite networks throughout
recorded human history depend on preserving power and wealth. Modern
elite networks, at least in democracies, are composed of politicians whose
desire is to preserve power and rent-extracting firms and their executives
whose desire is to uphold wealth. This book shows two things: first, it
establishes that both parts of an elite network benefit from proximity to each
other, and second, it establishes how their relationship impacts the
distribution of top incomes. In other words, it uncovers how both types of
powerful individuals benefit from being included in this network of
influence, and what unwanted consequences their relationship entails.
What are the typical outcomes that arise from an elite network
relationship and are somewhat observable in the data? Corruption is one. In
particular, a specific form of corruption from procurement contracts that are
allocated on a suspicious and hence potentially fraudulent procedure. Or the
type of corruption where politicians change urban planning laws and other
legal and regulatory procedures in order to benefit a specific set of actors.
The focus is on office-holding politicians, and the potential benefit they can
incur if they are part of informal groups to which they distribute rents and are
free to take rents from. There is no way, apart from criminal investigations,
to directly prove that the owner or CEO of the firm received a contract
because of their connection to a politician. However, in many cases based on
the firms’ relative performance and status it is possible to deduce a
potentially suspicious relationship that implicates the inner dealings of an
elite network. Corruption is therefore approximated through potentially
fraudulent procurement contracts received by rent-extracting firms whose
primary source of income is conditional on political connections to get
government contracts.
Examples include cases in which firms with no employees and as a single
bidder on the tender received procurement contracts worth millions, in which
firms signed contracts vastly exceeding their capabilities, or when firms with
substantial losses received indirect subsidies through lucrative deals. The
intuition behind the formation of each of these corruption proxies is based on
qualitative evidence using interviews with key stakeholders in the
procurement process. Observing fraudulent public procurements is the
easiest way to establish a link between corrupt politicians and rent-seeking
firms, especially if the allocation of procurements depends entirely on
discretionary power of the politicians. Chapter 6 uncovers the empirical
relationship between corruption driven by elite network membership and
political survival.
Another outcome that testifies to an elite network type of behavior is
when firms that are directly and undoubtedly connected to politicians (via
lobbying, campaign donations, or their high-ranking personnel) get favorable
deals from the government compared to similar firms that are not connected
to politics. Although the outcome need not be a direct result of elite network
membership, any causal effect of political connections on a government
subsidy again implicates the existence of an informal relationship through
which the decision-making process was molded. Empirical evidence of this
effect is presented in Chapter 7 by looking at the impact of firm-level
political connections on policy favors using the case of government bailout
(TARP) funds allocated to the US finance industry during the 2008–2009
financial crisis. Financial institutions that received TARP funds used
lobbying, campaign spending during the 2008 cycle, and direct links their
corporate management had with the decision-makers (Congress, Treasury,
Fed) to get a better bailout deal for themselves. Politically connected firms
were clearly favored over unconnected ones during the bailout allocation
process.
Arguably the most efficient way of quantifying an elite network is to
examine individual-level data of top corporate executives, specifically their
memberships in various organizations in addition to their career paths to see
if at any point they could have formed a relationship with the political
decision-makers. For example, a corporate CEO might have been working at
a top position in government prior to their position in the firm, which would
grant them preferential access to former colleagues if a firm needs a
government favor. Also, corporate bosses and politicians can be members of
the same country clubs or various societies, charities, religious groups, can
be tied together through think tanks and NGOs, and can often meet in informal
gatherings where they have direct access to privileged information. Once
such an informal relationship is established and caressed for a while, favors
can be exchanged. Once the executive successfully extracts rents for his firm,
he demands a higher compensation as a reward for his efforts. If this theory
holds, we would notice a clear difference in earnings between executives
who carry some type of political connection and those who do not. An elite
network member should always be compensated more than a nonmember.
The empirical findings of Chapter 4 confirm this theoretical intuition.
Politically connected executives, by assumption elite network members, tend
to have higher salaries and total earnings than nonconnected executives. They
are also better connected within the corporate world; however, the network
effect does not offset the political connection effect—if anything, it
reinforces it. The implication this carries for income inequality is striking. It
suggests that one of the main drivers of top wages of today’s supermanagers
are their political connections. Being a member of an elite network directly
implicates earnings of such individuals and hence drives up income
inequality.
⋆⋆⋆
Now that we have a proper contextual definition of an elite network, before
we can measure its direct impact on inequality, in Chapter 4, we first need to
offer a deeper historical portrayal of the evolution and persistence of elite
networks. Elites are an omnipresent feature throughout human history.
Whenever there was wealth and power there were elites that commanded it.
And whenever elites commanded wealth and power, unequal distribution of
wealth and income was a natural consequence. Chapter 2 delivers this
cornerstone argument by re-examining the history of mankind through the lens
of elite rule and the logic of power, while Chapter 3 focuses on
democratization trends arising in the late 20th century that made no
significant long-term impact on structural inequality primarily because they
could not disrupt the logic of power.
 PART I

THE IMPACT OF ELITE NETWORKS ON INEQUA

LITY

The first part of the book delivers the cornerstone historical and empirical
arguments that explain the direct impact of elite networks on inequality. The
existence of elite networks is contingent on having or being in proximity to
political power. As Chapter 2 shows, they are a persistent phenomenon of
human history and have existed ever since mankind started accumulating
wealth through surpluses from agricultural production. These initial instances
of wealth drove demand for the first proto-states and, by extension, the first
demand for condensing political power within a narrow set of individuals.
These were the primordial elites, granted a divine right to protect the
population and their food surpluses from outside threats. As civilizations
progressed, the societal role of the ruling elites has expanded to
unprecedented levels of authority and power. An unequal distribution of
wealth, condensed within the ruling elites, was a natural consequence. Even
as societies progressed further and got rid of the shackles of authoritarianism
and Malthusian poverty, elite networks remained.
In the 20th century, when democratization finally emerged, there was no
significant, long-lasting impact on structural inequality, as Chapter 3 shows.
Democracies, contrary to expectations, had no definitive impact on lowering
inequality. They introduced, for the first time ever, the concept of the welfare
state, and significantly expanded the size and scope of governments to
provide the basic public goods like health care and education. However, the
forces of wealth concentration among the privileged, well-connected groups
were never subdued. None of the great reforms and positive social trends of
the 20th century solved the real problem behind inequality—the proximity of
elites to political power.
Today, elite networks no longer represent a relationship between the kings
and the nobles, or between the rulers and the owners of land and capital.
Today, they are part of an interdependent relationship between a legitimately
elected politician and executives and/or owners of the most powerful
corporations in a country (except for dictatorships, where they are
manifested more or less the same way as during premodern times). Chapter 4
shows how modern-day “supermanagers” affect the distribution of incomes.
They exploit their proximity to political power in order to secure rents for
their firms, which reward such connected executives with higher salaries and
bonuses. This impact on the top 1% and 0.1% of income earners is the main
driver of higher inequality in modern-day societies. The same forces of
wealth concentration that have driven elite networking incentives for
centuries are present in modern-day democracies. Their impact on inequality
cannot be much different.
 2
Evolution of Elite Networks and Inequality
Inequality in the Very Long Run

Inequality was regarded as a normal condition and injustice as a personal misfortune or even as
an individual’s just deserts rather than as a social evil [. . .] the general pervasiveness of
inequality ensured that its legitimacy went unquestioned.
—Bruce G. Trigger (2003) Understanding Early Civilizations, p. 142

Elite networks are driven by the logic of power. Their perseverance

throughout human history, centered on the assumption that a powerful well-
organized minority controls the majority of a society’s resources and hence
wealth-seeking opportunities, implies that income and wealth inequality
were persistent features of recorded human history, at least ever since the
origin of the Agricultural Revolution some 10,000 years ago. Whenever there
was wealth, there were elites that wielded control over the extraction and
distribution of wealth. And every elite was focused on achieving authority, or
to put it simply, on achieving power over others: the power that granted them
both de jure and de facto rights over the lives and livelihoods of all others
beneath them. But no ruler could ever rule alone. Every ruler rested on a
close group of powerful subordinates who were rewarded for their loyalty
or, alternatively, who mounted coups against a ruler who no longer held their
support. Proximity to the ruler created incentives for the first elite
networking. It is here where alliances and enemies were forged. It is from
this relationship that the distribution of wealth was decided on.
According to Gerhard Lenski’s 1966 seminal book Power and Privilege,
inequality varied significantly throughout history and was determined by two
major forces: concentration of power and the size of surplus in a society (in
terms of available resources and technology). The rate of concentration of
power determined how much wealth (surplus) could have been extracted by
the elites for themselves. The more powerful the ruler and his clique, the
greater the level of inequality.1 This logic is confirmed by a more recent
research paper from Milanović, Lindert, and Williamson, who find that all
preindustrial societies were characterized by very high potential inequality,
or a very high “extraction ratio.”2 An extraction ratio measures the potential
level of inequality when wealth is concentrated in the hands of the elites.
High extraction ratios imply a greater probability that wealth is to be
extracted by the top income groups, and hence is the main characteristic of an
unequal society. The more repressive the ruling elite, the more unequal the
society. The many historical portrayals of inequality make it an inescapable
fact of life of all premodern societies, as exemplified by the opening quote to
this chapter.3
The theory of elite networks offers a new structural explanation behind
long-term cyclical inequality, one that is deeply rooted in the history of
mankind and molded by the insatiable thirst for wealth and power. We must
therefore go back in time to when wealth was first being created to
understand why elite networks were formed and why they yielded an almost
evolutionary incentive for a small ruling elite to confiscate societal wealth.
From then on, we can explain the cyclical nature of inequality and how it
evolved through millennia, subject to the constraints of autocratic and
extractive stationary bandit political orders, Malthusian economic orders,
and subject to the interchanging forces of wealth concentration and
occasional destruction.

2.1. The Agricultural Revolution: From Hunter-Gatherers to

Settlers
Our journey begins just before the Agricultural Revolution, the first major
source of inequality,4 commencing some 12,000 years ago (10,000 years
B.C.). By then our human ancestors lived mostly in hunter-gatherer societies,
foraging food and only moving from one place to another if the food supply
of their territory was exhausted or if a change in climate forced them to move
on. They were already living in kinship-based bands and tribes and had
established social ties between them. The early Homo sapiens, even as
hunter-gatherers and foragers, were very territorial. According to recent
anthropological findings, the effect of changing climate conditions, a global
cooling phase that lasted from 195,000 to 125,000 years ago, pushed the
Homo sapiens species from inside Africa to its coasts.5 There they
discovered ample amounts of coastal food, which to them became a dense
and predictable source of food supply.
This triggered high levels of territoriality among early humans, which led
to intergroup conflict. The conflict between tribes enabled conditions for the
formation of deeper social behaviors and norms within groups. They worked
together to protect their food sources in order to preserve exclusive access to
this resource. Early humans were therefore driven both by cooperation
(within tribes) and competition (between tribes). Cooperative behavior, in
turn, fostered innovation in new technologies, primarily in weaponry. The
first projectile weapons—spears, bows, and arrows—developed for the first
time around 71,000 years ago.6 Within-tribe cooperation was crucial for the
success in between-tribal competition for resources.
These technological advancements in weaponry coupled with within-
tribal cooperative behavior allowed the Homo sapiens species to easily
adapt to new environments, and encouraged their spread to other continents.
They first reached the Middle East around 55,000 years ago, which led to the
extinction of the Homo erectus. This was followed by further expansion into
Southeast Asia, which led to the extinction of the Denisovan humans, and
then to Europe some 45,000 years ago, leading to the extinction of the
Neanderthal. Their further spread to all other continents (Australia about
45,000 years ago, North America 14,000 years ago, and South America
13,500 years ago) was in all cases followed by extinction of anyone who
lived there—whether it was another Homo species or the megafauna (large
mammals and plants) that existed in the territory. The Homo sapiens, due to
their knowledge in the use of advanced tools and weapons, as well as
cooperation in hunting, were a constant threat to all big animals and other
species of humans they found wherever they settled. The violent and
destructive tendencies of our early ancestors were inscribed in their DNA
eons ago.7
Opposed to a somewhat romantic portrayal of the early hunter-gatherers
as peaceful idle humans, they were nothing of the sort. Violence and conflict
were not unknowns in the world of foragers. According to archaeological
excavations it seems that the early humans exhibited constant conflicts
between and possibly within groups. All this happened even before the
Homo sapiens started to spread and eliminate all other species of humans on
Earth. This obviously varied from one group to another, but evidence of
violent deaths of early humans certainly does suggest that violence and tribal
connections were powerful motivational factors behind early human
settlement.
Then came the Agricultural Revolution. Contrary to popular belief
enlisted in the name itself (revolution commonly suggests a swift change of
an old system with a new one), the Agricultural Revolution was a long and
gradual process where domestication of plants and animals and the
consequential sedentary lifestyle took centuries, even millennia to occur. The
process itself can be dated to sometime around 8500 B.C. in the Fertile
Crescent and about 7000 B.C. in China, reaching other continents only later.
Most importantly, it happened randomly and without the early humans
ever realizing it. Sedentary lifestyle was not a consequence of human
ingenuity or deliberate action—it was a consequence of chance. Jared
Diamond describes this accidental process of discovery: the plants the
foragers consumed (like wheat or various fruits) while spitting and
defecating their seeds started to grow around their temporary settlements,
particularly if they were located close to water and fertile lands (rivers like
Euphrates and Tigris in Mesopotamia or Yangtze in China).8 Once they
started to realize this, they turned gradually to cultivating those plants, but
still remained nomadic. Not until they started planting crops deliberately
were they forced to settle more permanently, a paradigm shift that lasted at
least a few thousand years. As more effort was needed to cultivate plants,
there was less time available to gather other food. This slow gradual change
affected the settlers’ procreation (populations began to grow) as well as their
diets, making it difficult to say when exactly the change occurred. What we
can be relatively certain of is that during its gradual adoption, the Homo
sapiens have hardly noticed it. Each new generation simply lived like the old
one, making only minor improvements. Getting used to a luxury often means
not being able to imagine life without it. Farming was the luxury, in terms of a
stable and predictable source of food supply, and it set the stage for the rest
of our development as a civilization. Not all hunter-gatherers became
farmers. Many gave up on it after even a few centuries and continued to
develop as nomadic tribes.
Yuval Harari develops the argument of how evolution played an important
role in switching the Homo sapiens from foragers to farmers: “the currency
of evolution is neither hunger nor pain, but rather copies of DNA.”9 In other
words, the higher the number of humans, the more successful the species. The
basic reproductive instincts of early humans changed once they settled down.
Farmers living a sedentary lifestyle could give birth to more babies and in a
shorter time span than nomadic hunter-gatherers. This implied growth of
population and considerably larger tribes of settled farmers than nomadic
foragers. Furthermore, sedentary lifestyle brought innovation in terms of
tools, and with the origination of food surpluses, stronger incentives for
protection. Tribes with strong within-group protection (in the form of first
organized units, guards, or even proto-armies) with better weapons could
have easily defeated the roving, nomadic hunter-gatherers, who had a choice
to adapt and become farmers themselves, face starvation (as their food
sources were being exhausted), be killed by the farmers, or leave to an
isolated territory and continue living detached and in peace (as some did
until the modern age, remaining relatively egalitarian). Therefore, one can
say that evolutionary motives led us to gradually accept a sedentary lifestyle
as this implied a larger number of units of our species. Evolution molded the
Homo sapiens into a sedentary species so as to ensure rising reproduction:
Man, like every other animal, has no doubt advanced to his present high condition through a
struggle for existence consequent on his rapid multiplication; and if he is to advance still higher, it is
to be feared that he must remain subject to a severe struggle.
—Charles Darwin (1871) The Descent of Man, p. 618

Human existence is consequent on rapid multiplication. Because their new

agricultural lifestyle made humans multiply as a species, their biological
urges made sure they kept on multiplying. The sedentary destiny of our
ancestors was sealed.

2.2. How Exactly Did Farming Translate to Inequality?

The sedentary lifestyle that turned foragers into farmers gradually changed
their behavioral patterns. According to archaeological excavations from the
early stages of the Agricultural Revolution, it was obvious that early settlers
already experienced inequality even before proto-states started to ascend.
There is ample evidence of burial sites where some bodies were buried with
vast amount of gold ornaments and other fine objects, suggesting the
importance of this person relative to everyone else in the community.
Especially noteworthy are burial sites of children who were buried with
lavish decorative objects, most likely suggesting that they were children of
someone important and/or where themselves the object of praise and awe.
This implies that in the early stages of the Agricultural Revolution there was
a tribal hierarchy in place where tribal leaders and their families enjoyed
greater benefits and hence a skewed distribution of wealth. Inequality
therefore did not commence with the rise of the state—it existed well before
it. The rise of the state only exacerbated early inequality due to an even
steeper hierarchical structure. This too was a gradual process, by no means
linear and simple, and driven by a host of factors: population growth,
demand for protection of scarce resources, the necessity for organization and
leadership, technological progress, and so on.
However, patterns differed between territories, regardless of hierarchy. In
some there was undoubtedly an increase in inequality compared to the
hunter-gatherer times whereas in others things remained relatively
egalitarian. New evidence suggests the domestication of large animals is
Eurasia played a crucial role in generating an unequal distribution of wealth
in early sedentary societies, and that this can explain the differences between
settlements across the continents.10
The impact of geography and climate was crucial. The Fertile Crescent
had a number of advantages for being the first territory with early settler
societies already in 8500 B.C. The most important factor was not the fertility
of the land, but its biodiversity. This was the largest area in size which
contained the largest amount of both plant and animal species suitable for
domestication. It had 32 suitable large-seed plant species compared to only 6
in East Asia, 5 in Mesoamerica, 4 in North America and Sub-Saharan Africa,
2 in South America, and 1 in South Africa. Similar for large animals. The
Eurasian continent had in total 14 large mammal species suitable for
domestication (from the major ones like cows, sheep, goats, pigs, and horses,
to the minor ones like camels, llamas, donkeys, reindeers, water buffalos,
etc.), compared to only 1 in the Americas and 0 in Africa and Australia, as
all the big animals in these other territories were either extinct (in the
Americas and Australia) or unsuitable for domestication (zebras, hypos,
rhinos, elephants, and giraffes are hard to tame, while the carnivorous
animals are simply too costly to feed). Mesopotamia therefore had the luxury
of having the perfect combination of mammal species suitable not just for
pulling plows but also in providing ample supply of meat, clothing material
(wool, skin) and easier transport. It also had the greatest variation in climate,
which favored the biodiversity, and a wide range of altitudes (from
mountains to lowland rivers) suitable for harvesting the different varieties of
plants and raising different varieties of cattle. This was important as it did
not confine the hunter-gatherers to stay in one territory but enabled them to
spread out and continue their unconscious gradual settlement.11
The advantage of suitable animal and plant species was not only crucial
in societal development of early settlers but also in the development of
patterns of inequality. According to new archaeological research the
availability of livestock to pull plows and transport both goods and people
made land a valuable resource.12 Places that did not have the luxury of large
mammal species relied on human labor, meaning that their development was
necessarily slower. You could cover much more ground much more
efficiently using animal force. Livestock virtually became the first primitive
form of capital. Many excavated graves revealed that the most important
people within a community regularly got buried not just with their material
possessions but also often with their cattle—in other words, their property.
Livestock and land were being transferred to future generation as inheritance,
and were also rented to families that could not afford to have them. Access to
livestock and land were therefore the first sources of wealth and the first
form of distinction based on wealth for early human settler societies.
The same research concludes that societies in which farming was labor-
intensive (based on human labor rather than animals) were much more
egalitarian than societies in which farming was land-intensive (where land
ownership was concentrated and livestock was the essential tool necessary
for harvesting and transportation). The average difference in estimated Gini
coefficients between the two farming systems (on a sample of 90 Euroasian
archaeological sites) was 0.3 in favor of the land-intensive systems (an
average of 0.5 in land-intensive versus an average of 0.2 in labor-intensive).
13

These findings are confirmed in previous research efforts looking at the

size of dwellings to establish within-society equality.14 They confirm that the
rise of early settler inequality was primarily due to restricted land usage and
that a land-limited societal order experienced much higher inequality than a
labor-limited order. This too is attributable primarily to the existence of
large mammals suitable for domestication in areas with higher levels of
wealth inequality. According to this study the average Gini coefficients were
0.17 for the hunter-gatherers compared to 0.35 for agricultural settlements.
The ability of the settlers to adapt mammals for transportation combined with
innovations in bronze metallurgy enabled the development of advanced
warrior groups that were able not only to defend resources but also expand
the settler’s territorial presence.15 The stage was set for the next logical step
in human development: the rise of the state.

2.3. Proto-States and the Formation of Hierarchical Orders

The sedentary lifestyle contributed to humans becoming even more territorial
and protective of their fragile food supplies. This change brought to one very
important difference in human behavior—planning and thinking about the
future. Foragers made no plans for the future. They preserved the food they
could carry and had very limited expectations about the food supply they
were to encounter tomorrow. If the food source was exhausted, they simply
moved on—a life very similar to that of our animal antecedents. Sedentary
farmers, on the other hand, had no such opportunity. They had to learn how to
plan ahead, how to manage to grow enough food to keep everyone in the
family unit fed through the winter, and most importantly how to adapt to
nature’s uncertainty regarding agriculture (the seasonal cycles—will it rain,
will the river rise enough to irrigate the crops, will there be a flood, how
long will the drought last, what if the season was poor, will there be enough
food, etc.). In time, people innovated to become less dependent on weather
and climate conditions. They adapted. They irrigated fields, they harvested
new crops to make extra supply in case the original crop fails, and invented
new tools that helped them adapt to weather conditions.
How did this affect their lives? Given that they invested a lot of time and
resources in their crops they were adamant in protecting them against roving
bandits (potential predators and freeloaders) and other tribes. If the roving
bandits would rob them of their entire food supply, this literally meant
condemning the farmers to starvation. A response had to arise. And it came
in the form of first proto-governments with protective armies, which would
be given a part of the farmers’ food supply (surplus) and offer their
protection as compensation. In Mancur Olson’s words, the roving bandits
were replaced by the stationary bandits16—the proto-state, and its ruling
elites: the kings, the priests, and the military. The stationary bandit has what
Olson calls “encompassing interest” within the territory that he controls. He
has the authority to extract and distribute resources and has incentives to curb
or promote violence. In other words, a stationary bandit monopolizes
violence and crime in one territory. This reduces the risk of outside coercion
and defines societies within the limits of expected coercion. It is from these
incentives that the first autocratic states were born, from ancient King Sargon
of the Akkadian Empire to all future autocrats and ruling elites. Autocracy,
operating under the same assumptions as it did in ancient times, was the
dominant social order for the vast majority of recorded human history.17
Geography again played an important role. States, as a necessity of
protection against outside violence, rose in densely populated river valleys
(like Mesopotamia or the Nile valley), where it was relatively easy for
predators and other tribes to attack, and which were bounded by a desert or
an ocean so that it was difficult for people to flee and escape violence.18 In
low-density areas people would run away, while in areas difficult to reach
attacks occurred with a lower frequency. Thus, the demand for protection,
and hence hierarchical organization that gave rise to autocratic elites, was
strongest in larger, denser, and geographically bounded areas where the
population had no choice but to stay put and invoke a protective agent.
In the first proto-states with the first forms of ruling elites, incentives
were created for the first primitive form of labor specialization. The majority
worked in agriculture, but some, arguably stronger individuals, had to be
used to protect the surpluses and thus became soldiers. The strongest among
the soldiers became army leaders and, by extension, leaders of the
community (this was nothing new, tribal communities always chose leaders
based on strength and appeal), while the smartest were used to write, to keep
track of the surpluses and later on debts. Early societies started forming their
own classes and the first hierarchical dominance structures. Rulers,
bureaucrats, and soldiers all started to have an active role: protecting and
organizing production so as to feed the community. The newly created
occupations relied on the farmers to feed them, while the farmers relied on
them for protection. This social contract obviously worked better in some
places than in others, but the very basis of the relationship served as a
crucial enabler of greater food production and by extension greater
population growth. Communities that grew larger in size were more
equipped to protect themselves from outsiders. This made them grow even
stronger over time. Communities were gradually turning into larger and
denser societies.
 As this change was occurring other things were necessary to bind the
rising population, to force them to cooperate and organize them into a
disciplined unit that can fulfill the societal function of food production and
further procreation. Two conditions were crucial to enable mass cooperation
between people who were no longer tied to a small community based on kin.
The first was a hierarchical dominance structure based on religion but also
trust and confidence in the upper echelons of the hierarchy to determine the
rules of a society. The second was the invention and usage of writing.
Harari refers to the first condition as an imagined order, a type of
subjective, made-up reality that enabled mass cooperation of early humans.19
People needed a hierarchy to believe in, so they invented one. They invented
gods and they invented the rulers. The process was autocatalytic, a positive
feedback loop; the ruling elites defined what was acceptable and what was
not, and drew their influence from divine power. The concept of religion was
not invented by the elites (as there is evidence that people believed in animal
gods during hunter-gatherer times), but it was certainly exploited in order to
preserve their position of power. Egyptian pharaohs declared themselves
direct descendants of the gods. As did many other rulers across ancient
history. This was the easiest way to convince people that the ruler is to be
trusted and obeyed without question.
There were strong incentives [. . .] for rulers to invest in the right spiritual infrastructure, such as
building of lavish places of worship. This offered a lever over internal control, allowing leaders to
form a mutually strengthening relationship with the priesthood who, across all the principal religions,
wielded substantial moral authority and political power. This did not mean that the rulers were
passive, responding to doctrines laid out by an independent class (or in some cases caste). On the
contrary, determined rulers could reinforce their authority and dominance by introducing new
religious practices.
—Peter Frankopan (2015) The Silk Roads, p. 28

Religious and political leaders in the first proto-states therefore created the
first ruling elites, all based on an imagined hierarchical order where divine
power is bestowed on a ruler who defines how a society and his subjects
should conduct themselves. It is exactly through this type of order that
cooperation is enabled among complete strangers. If a means of payment is
defined by the ruler by having his face printed on the coin, this implies a
certain value to that piece of metal that forces two parties who engage in
trade to respect its institutional character. They believe in the ruler and thus
they believe in his coin. Imagined hierarchical orders, defined this way as
beliefs in common myths and common gods, are not necessarily deliberate
manipulative mechanisms; instead “they are the only way to make a large
number of humans cooperate effectively.”20 They constitute a powerful
propaganda machine, as one does not dare to question the motives of the
ruling elite just as no one dares to question the motives of the gods. Religious
propaganda mechanisms enabled the ruling elites to justify their power
throughout human history; from ancient times until today.
The invention of writing was the second most important binding condition
in fostering cooperation and speeding up the expansion process of ancient
empires. Instructing social orders required a way to easily transmit them, in
ways other than gossip or word of mouth. Having a larger society implied
rapid expansion of information, all of which had to somehow be aggregated.
This initial demand for aggregation of information and the spread of rules led
to the invention of writing. Writing was first invented and used in ancient
Sumer between 3500 and 3000 B.C. by bureaucrats to note surpluses in food
and who owed what to whom. It was used for accounting purposes, which
later advanced into purposes of ruling a kingdom or an empire. Writing was a
crucial prerequisite of a well-functioning state, a state that can successfully
maintain political hierarchy and enforce order.
The two conditions, writing and a hierarchical order, also formed a
positive feedback loop. Writing enabled stronger political organization
developed in terms of a well-known hierarchy. The hierarchy created back
then, with the onset of states and rulers, was the one that was prevalent
throughout the rest of human history. A hierarchy between classes—the elites
consisted of rulers, priests, and soldiers versus the workers and the farmers
—evolved into a hierarchy between the rich and poor, a hierarchy between
owners and slaves, between whites and blacks, and even between men and
women.
Harari suggests all of these hierarchies were a product of our imagination
—this is how it is supposed to be. There is no natural distinction between
any of these imagined hierarchical orders, only what we have been imagining
throughout history. It is immensely difficult to rid ourselves of these burdens
as they are by now deeply embedded in our behavior. It is how our parents
were raised, how they raise us, and how we will raise our children. When
American forefathers signed the Declaration of Independence emphasizing
freedom, they were all slave-owners. Interestingly, none of them saw this as
a logical inconsistency, given that slaves were a fact of life, in a well-
established hierarchical order. The justification provided by white slavers in
the United States was that black slaves were less intelligent than white
owners, which is precisely why they were slaves. No matter how ridiculous
this sounds from today’s perspective, merely a few centuries ago this was the
dominant political hierarchical order and pseudoscientific studies were
being done to “prove” it. Slaves were merely subpar humans. And yet there
was never any natural, any biological reason for humans to behave this way.
Gender is a similar story. From the onset of civilization women were treated
as the property of men. In many legal systems rape was not considered a
crime against a woman, but a legal breach of property of the man who
“owned” her. The initial divergence between men and women, where men
used to hunt and go to wars against other tribes to protect their territories
while women gave birth and cared about infants, set the stage for this very
long imagined hierarchical order which is still dominant in many countries in
the world today. The reason for its persistence was the obvious initial
biological difference between men and women.21
The hierarchies that enabled order and dominance of one small group
over the entire population meant that at the top of the distribution there was
always an elite consistent of rulers, their vassals, and their priests who all
had complete control over the extraction and distribution of resources. Belief
in a dominance hierarchy enabled the elites to amass fortune gradually over
centuries—long enough for anyone to stop questioning what or who gives
them the right to seize control over the distribution of resources. Just as no
one, not even the ancient philosophical moral authorities like Plato or
Aristotle, asked why one should have the right to own another human being,
whether a slave or a woman. It was simply the belief system that existed in
society that everyone accepted and took for granted. A belief system that
developed for millennia. An imagined dominance hierarchy that gave the
ruling elites justification over the usage of force and violence in amassing
and redistributing wealth, enabled them to define ownership rights over land
and all forms of property—including other human beings like slaves and
women—and enabled them to use religion as a way of upholding their divine
right to hold power and justify all their acts of violence and extraction.

2.4. Concentration of Wealth in Ancient Civilizations: Rise of

the Malthusian Economic Model
The state was thus born out of demand for protection against freeloading
predators. People preferred the certainty of a stationary bandit—one ruler to
whom they had to give a predefined part (albeit large) of their food surplus
—to the uncertainty of having a number of roving bandits randomly killing,
raping, and pillaging their settlements. The demand for protection had the
effect of creating the first dominant hierarchical power structures where the
leader of the settlement was given unlimited power and the incentive to use
violence as a method of both protection and expropriation. This was a bad
deal for the farmers who still lived barely above subsistence levels given
that the newly formed elites usually usurped a huge amount of the food the
farmers produced. But at least they had protection and were able to alleviate,
to some extent, uncertainty about the future.
All of this evolved gradually, over several millennia. The first villages
(like Jericho) sprung around 8500 B.C. in the Fertile Crescent shortly after
the domestication of plants. By 5000 and 4000 B.C. there were cities across
the Mesopotamia (early Sumer and Babylon settlements), and by 3000 B.C.
the valley of the Nile was united into the first Egyptian kingdom, counting
several hundred thousand people—already an impressive early state. By
2250 B.C. the first empire was formed in Mesopotamia, the Akkadian
Empire, having over a million people and a strong standing army of over
5,000 soldiers. Between 1000 and 500 B.C. the world featured several
impressive empires and kingdoms; in addition to the Egyptian Kingdom and
the Late Assyrian Empire, there was also the Babylonian Empire and the
Persian Empire. At around the same period, in 508 B.C., Ancient Greece
was developing a democratic order in its city-states. After Alexander the
Great conquered the Persian empire in 330 B.C., the Qin dynasty united
China in 221 B.C., while in Europe, at around the same time, Rome was
starting its Republic and was beginning its expansion throughout the
Mediterranean. The Roman Empire (from 27 B.C.) was the most impressive
of the ancient empires, counting over 100 million subjects, and carrying an
army of between 250 and 500 thousand soldiers, not to mention developing a
road network still in use today in addition to a multitude of other innovations
and cultural contributions. The Agricultural Revolution took about 8,000
years to take us from the hunter-gatherers to the pinnacle of early civilization
—the civilizations from which we still, until this very day, draw inspiration
and influence.
 Precise data on income and wealth distributions during ancient times is
very difficult to find. We can only rely on archaeological findings and
historiographic material to try and understand the patterns of economic and
political development. From existing evidence, it is safe to conclude that the
rise of early empires merely exacerbated the already existing patterns in the
distribution of wealth. Inequality existed before the state, motivated by
ownership over land and livestock. Adding a clear hierarchical power
structure enabled it to rise even higher.
In ancient times the majority of the population lived barely above
subsistence income, while a small elite enjoyed significantly greater living
standards. This is exemplified by archaeological excavations of dwellings in
ancient societies (like for example in Pompei or ancient Egypt), which
showed that over 90% of the population lived in small, cramped houses,
whereas a select few lived in lavish mansions and large estates. Further
evidence from burial sites confirms that those living much better than the rest
were members of ancient elite networks—people in power and close to
power.22 Incentives for organizing into elite networks to wield control over
the distribution of wealth are as old as society itself. No matter which empire
we observe they all express the same pattern: proximity to political power
generated wealth.
Premodern states generated unprecedented opportunities for the accumulation and contraction of
material resources in the hands of the few, both by providing a measure of protection for
commercial activity and by opening up new sources of personal gain for those most closely
associated with the exercise of political power.
—Walter Scheidel (2017) The Great Leveller, p. 43.

In other words, the concentration of wealth in ancient states was in the hands
of those holding power and their loyal elite networks. Given that this elite—
the “original 1%” comprising the military, the clerics, and the rulers—
controlled the allocation of resources in ancient societies they were
effectively turning political inequality into economic inequality.23 Political
power was the sole determinant of wealth in ancient times, a pattern that
continued well until the 20th century.
To understand why political power rendered such a strong incentive for
wealth concentration, we must contextualize the economic model of
preindustrial times. The economies in ancient times (and in general during
preindustrial times) were all bounded by the Malthusian trap. In
preindustrial times both inequality and wages were driven by exogenous
events like wars, epidemics, or new discoveries that would primarily affect
population growth. Mean incomes stagnated relatively over time so only
changes in population growth would affect inequality. Lower inequality and
temporarily higher wages led to higher population growth among the poor,
which exerted negative pressures on their wages, increased inequality, and
subsequently increased mortality among the poor, driving population growth
down. Societies did grow slowly over time, and innovations in technology
certainly did occur over the centuries, as did changes in social norms and
cultures, but mean incomes were stagnant and living standards were tied to
mere subsistence. Any innovation in technology that would increase incomes
and make life easier would trigger population growth and the negative cycle
would be reinforced: greater population among the poor would increase
inequality, decrease wages, increase mortality, and again lower population
growth.24
Within such a constrained economic model, coupled with a stationary
bandit political model, neither of which allowed the voluntary market
exchange principle to fully evolve, the best way of enrichment and achieving
life beyond mere subsistence for an individual was to become part of the
elite network: to exploit the violence power principle. However, becoming
part of an elite network was not something made by choice. It was a
privilege attained at birth, by being tied to the right family with connections
to power. Proximity to power implied several potential methods of
enrichment: controlling surplus production, transportation links, trade flows
(by being granted permission from the state) or participation in conquest.
Authoritarian empires had a particular impetus for conquest. Conquest
meant further expansion and control over new territories and new riches;
from land to capital to slave labor. In the case of each conquest the ruler and
those in proximity to the ruler benefited the most: attaining new lands,
amassing new wealth, and seizing control over the newly acquired territories
as a reward for participating in battle. It was common for the conquerors to
award control over new territories to their closest generals and other elite
members. Alexander the Great gave each new territory he conquered to one
of his generals. The expansion of the Roman Empire was also contingent on
rewarding war veterans with land once they finished their service, and they
were also allowed to loot and pillage all newly conquered territories. The
higher the ranking within the army the greater the potential reward. Being
rewarded for engaging in conquest remained a powerful motive for military
conscription throughout ancient history and beyond. The Arabs and the
spread of Islam since the 8th century, the Viking conquests in the 9th and 10th
centuries, the Crusades in the 12th century, the Mongol expansion in the 13th
century, the conquistadores in the New World in the 16th century, the Ottoman
expansion since the 15th century, etc.—in each case the motivation was the
promise of enrichment and a better life (even if it were in the afterlife, as it
was promised to or believed by the Arabs, the Crusaders, and the Vikings).
Enlisting in battle was a good example of how engaging in something that
carried a high risk of getting killed was still a better choice than living a life
barely above subsistence in ancient and preindustrial societies. The
incentives for engaging in violence drawn from power offered a much better
chance of attaining a better life than by engaging in voluntary exchange (this
argument is further developed in Chapter 5).
The decision to engage in conflict, just like the decision to accumulate
wealth, was in each case confined on the rulers and their close elite
networks. In order to benefit from conflict or from controlling production
surpluses it was really necessary to be part of an elite network. Ancient
China, for example, the first state with a multilevel administrative
bureaucracy had a highly hierarchical social order with the concentration of
power entirely in the hands of the emperor and loyal highly ranked imperial
officers. Between them they exchanged favors and were particularly prone to
corruption and violence, deciding who gets control over land, labor, and
means of production (capital). The high-ranking elite network members
enjoyed protection from the emperor in that they were safe from any
prosecutions, could freely exploit anyone around them, and had virtually no
constraints on their rent-seeking activities. As a consequence, nobles and
high-ranking officials established powerful coalitions to support each other
and often intermarried to limit wealth dispersion and ensure that civil service
jobs in the Empire were almost exclusively hereditary.25 Powerful families
ruled China for centuries. The extreme lack of social mobility meant that
there was very little hope for anyone born outside the upper classes to ever
achieve an above-subsistence living standard.
It was a typical stationary bandit political model that became embedded
in the very core of Chinese politics, a trait that is visible even today. Clark’s
research on social mobility based on rare elite surnames shows a remarkable
level of persistence of elites in the upper income and wealth brackets that
tends to last for several centuries. His research in China shows that despite
the Communist revolution in the 20th century that had the explicit goal to rid
the country of its century-long class enemies (killing or impoverishing tens of
thousands of landlords, businessmen, and powerful families), Chinese elites
are still overrepresented in the top income groups in China today. Even
within the highest ranks of the Communist Party the prerevolution elites are
counted among its most powerful and richest members.26 To borrow an
expression from economic theory, elite persistence tends to be very “sticky”
over a long period of time.
Rome experienced an elite network hierarchy very similar to that of
ancient China. As Rome expanded its power, first as a Republic and then as
an Empire, its rise was supported by an aristocracy in the Senate who made
all the decisions on military conquests, on the allocation of senior officials in
public office, including appointing the prefects of the Roman provinces, and
widely encouraged rent-extraction among the elites. Personal wealth
accumulation among the elite networks in Rome was entirely based on
proximity to the Senate and later to the emperor. It was a heavily stratified
society where the top 1% controlled the majority of all wealth above
subsistence.27
Rome, however, was politically volatile. Periods of great distress in the
final decades of the Republic and periods of great uncertainty under some of
its most ludicrous emperors implied vast instability for the elite networks.
Internal conflicts often changed the fortunes of aristocratic families, as did
the violent redistributions during many civil wars and fights for power. This
most likely had a negative effect on the forces of wealth concentration and
disabled them from pushing wealth inequality to astronomically high levels
in Roman times. Stability is the best impetus for wealth concentration in the
hands of the elites. If these elites keep changing during periods of violent
upswings it is unlikely that inequality reached permanently high plateaus
during Roman times, despite the extractive elements of its political stationary
bandit model. It was most likely cyclical, as it was during the entire
preindustrial age. The downfall of the Empire in 476 obviously further
destabilized the accumulation of wealth among the existing elite networks
(except for those in the Eastern Empire, Byzantium), and drove inequality
down in yet another cyclical swing. The forces of occasional destruction
were quite frequent in Rome, which explains why despite obvious political
forces that allowed heavy wealth concentration, the Gini estimates based on
social tables from Roman times were not as high as expected (around 0.4 in
income inequality28).
In ancient times, the evolution of incentives for coercion and wealth
accumulation within the constraints of the Malthusian economic model
suggests that the forces of wealth concentration were already very strong and
heavily contingent on the position of power. The stationary bandit political
model coupled with a Malthusian economic model ensured the persistence of
wealth concentration among the elites. As societies moved on to feudalism,
mercantilism and colonialism, the forces of wealth concentration only grew
stronger.

2.5. The Long Malthusian Trap: Inequality and Elite Concen

tration during the Middle Ages until the Industrial Revolutio
n
The underlying mechanism behind development patterns of societies after
ancient times during the Middle Ages and all the way up until the Industrial
Revolution was not much different from what had happened since the
emergence of first empires. After the fall of the Roman Empire medieval
kingdoms and the allegiance they had to the Catholic Church in Europe
expanded the extractive stationary bandit model even further. The nobility in
Europe formed the feudalistic model of extraction, which was little different
from the patterns of development of the first proto-states: a feudal lord
owned the land on which peasants were allowed to live barely on
subsistence income, having a social status not too different from slaves. This
system, however, was more decentralized than in times of ancient empires,
but instead of one stationary bandit ruling over a vast territory there were
multitudes of local stationary bandits all of which formed nobility within a
single state; a nobility which had to pledge loyalty to the king of the land, to
the Church, or both.
The Catholic Church of the Middle Ages was perhaps the best example of
a stationary bandit model. It featured a strong dominance hierarchy with a
well-oiled quasi-bureaucracy supported by a diverse network of priests
across the Christian world, who during the Middle Ages were often the only
literate people in a community. Coupled with their monopoly over
interpreting religious doctrines, this gave them significant localized power,
similar to the power held by feudal lords. Furthermore, the Church had the
best possible religious justification of the pope’s power, and it could rely on
a well-defined elite network in terms of kings and nobles loyal to the Church.
The pope had the exclusive power of giving legitimacy to each and every
king in the Christian world. It was very easy for the Church to form alliances
this way and become the crucial source of power during feudalism. Most
importantly, the Church carried a strong desire for conquest and territorial
expansion. Their goal was simple—spread Christianity as far as possible
and maintain a strong monopoly over its interpretation and its direct link to
God.
The Crusades were a typical example of the power of the Catholic Church
during those times. A massive military conquest which was justified by
religious ideology of returning the city of Jerusalem into the hands of the
Christians and away from Muslim “infidels,” and which offered rewards in
terms of eternal redemption for anyone who would engage in conquest.
Behind it all was the desire of the Church to control the trade links between
the East and West and establish territorial and ideological dominance in the
world.29 The Church relied on a powerful elite network comprising the kings
of England, France, the Holy Roman Empire, Italian city-states, and all
territories under its dominion. Once the Church realized its immense power
through the ability to raise a massive army on several occasions during the
12th and 13th centuries (regardless of the fact that many Crusades were
unsuccessful and often complete fiascos), it established this practice
throughout subsequent centuries and the papacy became one of the most
powerful political positions in the world.30
The Church and its elite network of kings and nobles owned the majority
of wealth during the Middle Ages and beyond in Europe. A feudalistic
economic extraction model ensured that wealth concentration among elite
networks was extremely high until the 19th century, reaching up to 0.9 in
certain cities and periods. However, as Figure 2.1 suggests, wealth
inequality in Europe during those times, over a period of 500 years, was
gradually rising but with cyclical swings, within a range between 0.5 and
0.9.
Figure 2.1 Average wealth inequality in Europe from 1300 to 1800. Included are estimates of wealth
Gini coefficients for Italian city-states, and selected cities in England, France, Germany, Netherlands,
and Denmark. Sources: Alfani and Ammannati (2017), Sussman (2006), and Scheidel (2017).

The reason behind the cyclical nature of inequality throughout the Middle
Ages and even after the discoveries of the New World and the Enlightenment
movement, was in the realization of random events that occasionally
destroyed wealth and disrupted existing elite networks.
The stationary bandit political economic model of Malthusian times
suggests that the forces of wealth concentration should have kept the
concentration of wealth in the hands of the few a persistent phenomenon over
time. The trend in Figure 2.1 does hint that inequality had the tendency to
gradually rise over time. The forces of wealth concentration work best when
uninterrupted by periods of instability. But Europe during the Middle Ages
and beyond was anything but stable, with persistent episodes of conflict,
state failures, and pandemics that caused certain dents to the gradual increase
of inequality. Such was the strength of the forces of wealth concentration that
these random events had to have been of very significant magnitude to cause
a dent in the trend. The impact of the 14th-century Black Death is a good
example, visible through its immediate and sudden impact on wealth
inequality, shown in Figure 2.1 for Europe on average and in Figure 2.2 for
selected Italian city-states. After this one-off random event wealth inequality
rebounded and continued to increase, absent any other major structural
shocks.
A similar impact on inequality in later periods was attributed to war, state
failures, or any other type of pandemic. In the case of Augsburg in Figure 2.2,
for example, the decline of wealth inequality in the 17th century was due to
the impact of the Thirty Years’ War, which resulted in killing 20% of the
German population. Another very powerful leveling force.
The forces of occasional destruction led to massive leveling of inequality
primarily because they adversely affected the rulers and their elite networks.
The greater the destruction of wealth or human lives, the greater the negative
impact on inequality.
Figure 2.2 Wealth inequality in selected European cities: Italian city states (Piedmont, Poggibonsi,
Lucca, Tuscany), Augsburg in Germany, and the northern and southern parts of The Netherlands.
Source: Scheidel (2017), chapters 10 and 11.

Once a society recovers from the forces of occasional destruction, its

forces of wealth concentration continue to provide the same incentives for
extractive elites. It happened throughout the preindustrial world, regardless
of cornerstone events such as the New Discoveries or the Enlightenment.
This is once again best exemplified by Clark’s research on social
mobility based on rare elite surnames. The descendants of the nobility that
was created throughout the Middle Ages are still in the upper tail of income
and wealth distributions in many societies today. Clark defines a law of
social mobility that predicts a family’s regression to the mean gradually over
time in terms of its fortune and relative status. The logic here is simple: new
generations are not necessarily as competent and successful as the previous
ones, suggesting that their share of good luck runs out, and the family
gradually loses its wealth and its importance. However, for most elite
families this regression tends to be very slow and can last up to five hundred
years. For some families the regression never happens, meaning that certain
medieval elites have successfully preserved their relative hierarchical
position within a society over several centuries. This remarkable finding is
persistent across a wide range of societies that Clark and his associates look
at, societies with very different historical patterns of development. Their
argument is first confirmed in Europe in Sweden and England, extended
surprisingly to the United States, where family dynasties were much younger
than in the Old World, and further verified in Asia on the cases of China,
Japan, Korea, and India, but also in South America in the case of Chile. Most
interestingly their findings were confirmed among specific minority religious
or ethnic groups like the Jews, Copts, Roma, Protestants, or Muslims in
selected societies who all preserved their status through intermarriage
(similarly to the castes in India), meaning that they either sealed their status
at the top of the income distribution or at its bottom.31 The origins of
contemporary inequality and lack of social mobility in many nations can
therefore directly be traced to Malthusian times of stationary bandit
extraction-based politics. This is the legacy of elite networks on the
distribution of income and wealth, a legacy that spawns across several
centuries.
The same patterns existed beyond Europe. In Asia, religion and culture
were different but the logic of elite rule was almost identical. In the Arab
world and Persia, the same type of authoritarian stationary bandit model
ensured that wealth was heavily concentrated in the hands of the
caliph/sultan, their dynasties, and the nobility that supported their rule. The
Chinese imperial rule and its corresponding bureaucratic elites were hardly
any different. The Mongol conquests of the 13th century that were
characterized by brutal violence and resulted in the second-largest empire in
history (topped only by the British Empire in the 19th century) were a perfect
example of the impetus for conquest resting on the violence power principle.
Their rule was also heavily contingent on an elite network formed by the
heirs of Genghis Khan to later rule the empire. It was no different from
ancient China or ancient Rome. The cultures of the Mongol empire, the Arab
world, or China were very different from European medieval structures, and
were in many instances more advanced and carried greater ability to
innovate and design new technologies. The Arab world and China were the
centers of innovation and places where lavish wealth could have been found
for centuries.32 However, their economic and political models were still
molded by identical incentives used by the medieval elites in Europe: the
incentive to coerce using power allowing the forces of wealth concentration
to take full effect.
It would be wrong to conclude that societies did not change during
Malthusian times. They almost certainly did: they evolved, innovated,
adapted new technologies, built lavish infrastructural objects, and grew in
size, but progress was slow, daunting, and entrapped. Preindustrial societies
before and after the Great Discoveries were all bounded by the Malthusian
economic model, enabled by the extractive stationary bandit political model,
allowing the forces of wealth concentration to develop virtually unhinged,
halted only by random forces of occasional destruction, and guided by the
violence power principle.
Did these incentives change at all with the Industrial Revolution? The
world, as we know it, changed completely. Wealth creation for the first time
in history became inclusive, which gradually led to forces of democratization
and an unprecedented rise in living standards and technological innovation.
The Malthusian trap was broken. But inequality persisted. Elite networks
persisted.

2.6. Wealth Concentration and Elite Power in the 19th and 2

0th Centuries: From a “Society of Rentiers” to a “Society of
Managers”
The early years of the Industrial Revolution followed a familiar pattern of
elite enrichment at the expense of the rest of society. The transition from
agriculture to industry and the breakthrough from the Malthusian trap should
have enabled inclusive wealth-seeking opportunities and increased social
mobility for everyone. This did happen, but it developed gradually over a
very long period of time and was not entirely endogenous. It took two of the
most vicious wars in human history, followed by a battle of ideas between
socialism and capitalism, to start bringing down inequality and increasing
opportunity through a more inclusive democratic capitalist system. A
bourgeois middle class started emerging and exerting pressures for reforms
and gradual democratization (exemplified by the Reform Acts in England).
But all this took time. The initial benefactor from the early rise of capitalism
in the mid-19th century was neither the poor disenfranchised majority nor the
emerging middle classes; the initial benefactors were owners of land and
capital, the preexisting elite networks.
In his book Capital in the 21st Century Thomas Piketty delivers an
accurate portrayal of inequality trends during and after the Industrial
Revolution. Before the 20th century inequality in Europe was driven by
income from capital and land, extracted through rents. The vast majority of
capital and land were almost exclusively in the hands of the elites. The kings
and the highest ranks of the nobility were the top 1% of earners, and they
owned between 50% and 60% of all wealth in a country. The other 9% of top
earners, consisting of landed gentry (lesser ranks of the nobility) and clergy,
owned between 30% and 40% of all wealth, meaning that the top decile of
earners in a typical early industrial society owned over 90% of all wealth
(see Figure 2.3). Such a distribution of wealth was a common characteristic
of preindustrial and early industrial societies.33
The logic of elite networks did not change with the onset of the Industrial
Revolution. Only its structure changed. In the 18th and early 19th century the
best way to attain above-subsistence wealth was still through ownership of
land or capital, a privilege held only by members of elite networks. Wealth
was preserved through inheritance and between-nobility intermarriage. The
vast majority of the population owned almost no wealth at all (90% of
earners owned less than 10% of all wealth in the 19th century), so their
opportunities in life were not too different from ancient times. The existence
of basically two classes in preindustrial times translated into the struggle
between the owners of capital and the working classes as societies made the
transition from agriculture to manufacturing. The rise of the merchant middle
class had not yet made its impact. What were feudal peasants in the earlier
era now became the low-paid expropriated workers in the 19th century. The
early Industrial Revolution era became the origin for the battle of ideas
between capitalism and socialism, exemplified not only through the works of
Karl Marx and the rise of communist ideology but also in culture through
novels of Jane Austin, Charles Dickens, Honoré de Balzac, Émile Zola, etc.
Capitalism—attaining wealth based on capital ownership—became the
dominant economic model of postindustrial times, while socialism—deriving
attractiveness to the masses from its emphasis on worker oppression—
became its main alternative, to be fully achieved only in the aftermath of the
20th-century wars. Internal pressures for democratization (in the form of
rising middle-class power34 and interelite competition35) made gradual and
irreversible changes over time, but they never usurped the logic of elite
networks; proximity to power was as important as ever.
Ferguson testifies to this high concentration of global wealth and power
within the select few European empires,36 all of them under the control of
even fewer powerful families (the two most prominent being the Rothschilds
on the corporate/financial end and the Saxe-Coburg-Gotha noble family on
the imperial/dynastic end):37
National economies fell increasingly under the sway of large industrial corporations, whose owners
and managers, along with the bankers who financed them, began to constitute a new social and
political elite, albeit one intimately connected to the old regime. The map of the world by 1900 was
an imperial jigsaw, with eleven Western empires controlling disproportionate shares (58 per cent, in
all) of earth’s territory, not to mention its population (57 per cent) and economic output (74 per
cent).
—Niall Ferguson (2017) The Square and the Tower, p. 151.

The new capitalist economic model eventually did create new opportunities
for disruptive innovation and capital-intensive production in a number of
industries. This was by far the most important long-run impact of the
Industrial Revolution and is exemplified by the rise of the middle classes.
Gradually, new elites emerged as well by exploiting the new vast
opportunities, but attaining significant wealth was still highly contingent on
political power. A person who lacked political backing could not build a
business empire and become part of an elite network. They could pursue
opportunities on their own and achieve decent living standards, but they
could not become rich without being close to power. Gilded Age robber
barons hardly could have achieved their dominance without the backing of
the government, nor could any large corporation in England, France, Spain,
Austria-Hungary, or Prussia. For the first time in history, it was becoming
possible for a nonnoble person to achieve above-subsistence wealth through
the realization of the free exchange principle, but success was still contingent
on the violence power principle.
The consequence of the Industrial Revolution was to enable inclusive
wealth creation to all, however it also set the stage for the rise of another
powerful elite network: between government and business. The internal
composition of elite networks changed. Kings and nobles were slowly being
replaced by politicians and owners of big corporations. The Tammany Hall
political machine mentioned in the Introduction was a typical example of
19th-century collusion between politics and business. The levers of power
had shifted. The kings and queens were being overthrown by revolutions
(violent or peaceful) and replaced by modern governments, while the nobles
who owned land and capital were being replaced by powerful industrialists
carrying monopoly licenses granted by the state, or better yet, by friendly
politicians, thus constituting a new elite network. The structure has changed,
but the logic remained.38
It is thus no wonder that capital continued to dominate wealth
concentration of pre-20th-century elites. Even after capitalism developed
into a much more inclusive economic model in the 20th century—a
consequence of continued internal pressures, the rise of the middle classes,
and greater demand for public goods and redistribution—the logic behind
elite wealth concentration remained unchanged. One thing did change:
income from capital was no longer the main source of wealth. In the 20th
century income from labor took over.
Figure 2.3 Share of total wealth among top 10% of wealth holders from 1810 to 2010 for England,
France, Sweden, and the United States. Source: Piketty (2014).
Figure 2.4 Share of total wealth among top 1% of wealth holders from 1810 to 2010 for England,
France, Sweden, and the United States. Source: Piketty (2014).

What caused this dramatic switch from capital to labor? Figures 2.3 and
2.4 paint a very clear image of the development of elite wealth in the 19th
and 20th centuries. The top 10% of earners owned 90% of wealth in the Old
World (selected European countries: France, England, and Sweden), and
60% in the New World (United States), although the share of top decile
wealth in the United States rose to over 80% by the beginning of the 20th
century. The numbers for the top 1% are even more staggering: the very
pinnacle of elite networks, the wealthiest nobility and capital owners, by the
end of the 20th century owned almost 70% of all wealth in England, up to
60% in France and Sweden, and around 40% in the United States. Then came
Scheidel’s “four horsemen”:39 the two World Wars, a post–World War I
influenza pandemic (which killed even more people than the War itself), a
major economic crisis and hyperinflation, dissolutions of former empires,
and communist revolutions—all four major forces of occasional destruction
acted together within a relatively very short time span of only 30 years. The
composition of wealth owned by those at the top changed dramatically, as
did the very structure of elite networks.
The outcome was a more equal society by the end of the 20th century than
it was after the onset of the Industrial Revolution. The top 1% earners in
Europe owned about 20% of all wealth (in America it went up to 30%),
while the top decile owned around 60% of all wealth in France and Sweden
and almost 70% in the United States and United Kingdom.40 Despite having
lower numbers than in the 19th century, for many people this is still too high,
particularly when considering the rising trend over the last few decades of
the 20th and the first decade of the 21st century. A period of relative stability
once again allowed the forces of wealth concentration to generate higher
levels of inequality.
The relationship between capital and labor changed, and this reflected the
patterns of selection in elite networks. No longer were elite networks
composed of owners of capital and land, living off rents. In the 20th century
they started to include those whose incomes depended on wages rather than
rents. Societies made a switch from what Piketty calls a “society of rentiers”
to a “society of managers.”41
To exemplify this shift Piketty uses Balzac’s famous 19th-century novel
Père Goriot, where one of its shady characters, Vautrin, offers his life lesson
to the main protagonist. Vautrin’s lesson is that an average person’s best
chance of achieving above-subsistence living standards in the 19th century
was to inherit wealth (or marry someone who is an inheritor or rentier).
Income from labor was simply not rewarding enough. Figure 2.5 shows this
logic: if a person wanted to be rich, inheritance (or marrying a rich widow)
was much more likely to generate wealth than income earned from labor. An
inheritor in the top 1% of income earners (living off rents) had about 2.5
times more income than a top 1% labor earner. Ownership of land or capital,
attained usually through the violence power principle (as either a benefactor
of political power or an inheritor of wealth that was once created through
coercion) was more lucrative than any job a person might have held at that
time.42
Figure 2.5 The relationship between income from rents (in this case in the form of inherited capital)
and income from wages in France. The graph compares ratios between top 1% and bottom 50% of
income earners from both inheritance (rents) and labor (wages) from the late 18th to the 21st century.
Source: Piketty (2014).

As Figure 2.5 further suggests, this relationship started to change already

by the end of the 19th century and was completely reversed in the first part of
the 20th century. For the first time in history labor-based income became the
main source of wealth. This happened primarily because the role of capital-
based income experienced a massive decline. The reason for this was most
likely the aforementioned gradual rise of the middle classes followed by the
impacts of the world wars. Families from lower income brackets slowly
started to accumulate some wealth of their own, thus reducing the ratio of
inheritance of the top 1% to the bottom 50%.
Another interesting observation from Figures 2.3 to 2.5 is that the French
Revolution of the late 18th century did not really affect the patterns of
inequality or wealth concentration in France. The king was overthrown, as
were many of his loyalists, followed by several years of brutal internal
power struggles. However, elite networks obviously persisted, as their
wealth was unharmed. Even the age of Napoleon did not have any adverse
effect on wealth inequality in France—on the contrary, the top deciles
expanded their wealth concentration during and after those times. The largest
impact on inequality in Europe (and France by extension) was still made by
the 20th century’s four brutal forces of destruction: two major wars, a
pandemic, revolutions, and dissolutions of empires.
The most important conclusion from Figures 2.3 to 2.5 is that societies in
the 20th century made the switch from rentiers to managers, from capital-
based income to labor-based income. Today’s elite networks are different
from the pre-20th-century elites in that their source of wealth is no longer
exclusively tied to capital or land ownership but is instead driven by their
relatively higher wages. Today’s top 1%, or more precisely the top 0.1% of
earners—the pool from which new elite networks are created—comprises
senior corporate executives (CEOs, board members and presidents) of
publicly traded firms in the real sector, finance executives and professionals
(from banking to hedge funds), top corporate lawyers and consultants,
disruptive entrepreneurs (like Musk, Bezos, Gates, Zuckerberg, Jobs, etc.),
various superstars (from the performing arts, media, or sports), and the
occasional real estate mogul.43 Most individuals in this category draw their
incomes primarily from labor, even though they obviously also benefit from
exposure to financial markets through shares in their expanding empires and
other investments. Structurally the elites are different from before; they are
no longer made up of rentiers (inheritors and rentiers are still present but are
far from being the majority group), but their outcomes are still in many cases
contingent on their proximity to political power (as will be shown
empirically in Chapter 4).
The postindustrial era thus saw a complete change in the composition of
elite networks. First, the nobles and the aristocracy were replaced by
industrialists running huge corporate empires. They were the new
aristocracy, still drawing their wealth from capital ownership (and to a much
lesser extent from land ownership). A crucial transformation here is that for
the first time in history elite membership was no longer exclusively
hereditary. The new owners of capital, 19th-century industrialists, became
wealthy because they took advantage of existing opportunities. It was the
emergence of the voluntary exchange principle, although with an important
caveat—building a monopoly in steel, oil, or railroads was heavily
contingent on having access to political power. The second big
transformation was from the industrialists to the managers, triggered by the
shift from capital-based income to labor-based income as exemplified in Fig
ures 2.3 to 2.5. Competence, talent, and hard work became more important
than ever, hereditary status became relatively marginal, but proximity to
power was still immensely important. Both of these transformations
dramatically affected the internal structure of elite networks—kings and
nobles were replaced by elected politicians and corporate executives—but
their internal dynamics did not change: the emergence of the free exchange
principle did not annul the violence power principle as the key driving
mechanism.
We see this in the consequences of rising income inequality in the late
20th century, when the forces of wealth concentration during periods of
prolonged stability once again exacerbated the logic of elite networks. The
rise of income inequality since the 1970s, mostly in Anglo-Saxon countries
but also across the Western world, was primarily a consequence of the rise
in wages and nonwage incomes of the top 1% and top 0.1% of income
earners. Salaries, bonuses, and capital gains from investments in the financial
markets were responsible for a large part of this increase in top incomes.44
Many economists describe this rise of salaries as abnormal because their
growth was larger than the productivity gains of the companies. The increase
of top managerial salaries was a consequence of many factors, but mainly it
was due to an increasing demand for top talent (the so-called superstar
effect) which significantly affected their position in the social hierarchy.
Their talents led them to become part of the new elite network. The pre-20th-
century elites built their wealth on coercion and ownership of land, capital,
and often people. The 20th- and arguably 21st-century elites built their
wealth based on talent, but also, as we shall see in many cases, proximity to
political power.
Nevertheless, talent and competence are not the most important
determinants of the new elite’s incomes. Something else is playing a crucial
role, as it did throughout human history: the network effect. Top corporate
executives in publicly listed firms, despite having quite dictatorial
tendencies, do face some constraints on their power. Many CEOs
successfully avert this by playing office politics and appointing a Board of
loyal members who will never question their authority. Occasionally, due to
pressure from shareholders, a CEO does get punished if he or she does not
deliver; if revenues are stagnating and/or share prices are going down. The
best way of proving their worth to the company and satisfying their
shareholders is by maintaining connections to the key decision-makers in
power.
Corporate executives tend to exhibit a high level of degree centrality
within their networks. Degree centrality implies that they position themselves
in a key space within a network where they can maximize their connections
to the widest number of important people (executives of other companies and
politicians). Their connections directly enable them to secure exclusive
contracts and big jobs that benefit their companies. Hence, they signal their
value to the shareholders and are thus able to justify their high salaries and
bonuses. In other words, they draw their higher earnings by being well
connected, among others, to politics. It is the same logic of elite networks
that existed throughout human history. The only exception is that today the
connections within elite networks are not rewarded directly through spoils
from plunder or control over land, but indirectly through exclusive contracts
from public tenders that deliver abnormal compensations to the key nodes in
the network.
The cycle of history continues. Elite networks once again draw their
influence from political power. As it was in ancient history and throughout
preindustrial times, the dominant position in the social hierarchy is still
somewhat dependent on proximity to political power. It is hardly the only
determinant of wealth. Talent, competence, and a host of other factors are
still important—which is the crucial difference between today and
preindustrial times—but proximity to power still remains a very important
determinant of wealth for someone in the very top of the income distribution,
someone who is a member of an elite network.
The role of politics has also changed in terms of the tools the rulers have
at their disposal. No longer are leaders in democracies allowed to use
coercion and violence (at least when it comes to domestic affairs, where
constraints do exist), but they still hold enough power in distributing huge
government budgets. In fact, the size of modern-day budgets gives the
politicians in office immense power in the distribution of wealth. Anyone
who depends on the allocation of government budgets, on procurement
contracts with the government, or on regulatory or legislative decisions
granting a privileged position on the market, or anyone seeking to promote a
certain policy will have an interest in being connected to and influencing the
decision-makers in power—through lobbying, campaign spending, funding
various pressure groups, or directly affecting allocation decisions. All such
actions necessarily lead to a rise in top incomes, thus widening income
inequality.
The foundation of an elite network is to gradually build influence through
informal gatherings and events where decision-making politicians meet with
industry executives. Political influence is rarely bought openly and directly
(at least in institutionally well defined democracies). It is more often gained
indirectly, where an executive enters into a long-term mutually beneficial
relationship with a politician. Important government allocation decisions are
therefore rarely done through a predefined institutional mechanism. It takes
time to forge relationships and gain trust among the power structures, but
once trust is achieved, favors tend to be exchanged at a very fast pace. Most
importantly—everyone benefits.
⋆⋆⋆
Inequality is a persistent phenomenon of human history. It originated with the
onset of agricultural production and has been sustained through the use of
political power. It spreads across all economic and political systems. High
levels of inequality characterized all agrarian societies in the past, where
autocratic elites condensed all the wealth. The Malthusian economic model
coupled with the stationary bandit extractive political model did not give
many opportunities for wealth accumulation to anyone outside of the
dominant elite network. Political inequality, or the inequality in the
distribution of power, was the primary source of income and wealth
inequality throughout preindustrial history. This artifact of societal
development was, and still is, a key characteristic of many states and nations
—all, in fact, that have had or still have some type of authoritarian rule. High
levels of inequality were found both in socialist countries of the late 20th
century, where the elite is realized through partocratic or autocratic rule, and
in modern democratic capitalist countries, where the elite exists as a
combination of political and corporate power. The common denominator
across different socioeconomic systems and different time periods is a
powerful elite and its network—be it a network of dictators and their
cronies, a network of politicians and corporate bosses, or a network of kings
and nobles.
In the 20th century the levels of inequality fell to historic lows,
particularly in the aftermath of the two world wars. The rapid rise of living
standards and huge increases of productivity lifted hundreds of millions from
relative poverty and introduced them to a living standard greater than that of
the kings and queens of the earlier ages, or any elite network that existed thus
far. Rapid economic growth in the 20th century, provided by the emergence
of the voluntary exchange principle, sent shockwaves throughout civilization
making each new generation much better off than the one before. There is no
doubt that this encompassing economic progress increased social mobility
and lowered the levels of income and wealth inequality in the 20th century,
compared to the centuries before. The rise of capitalism and the subsequent
enrichment of the middle and upper classes who demanded more democracy
and franchise extension during the 19th and the 20th centuries had a gradual,
century-long impact on broadening the participation rates in wealth creation.
As more people were allowed to engage in creating wealth and making a
decent living from their labor input, an exploitational model of 18th-century
capitalism was gradually being replaced by a more inclusive model of
capitalism (at least in the countries of the Western core—as long as their
colonies still provided enough resources that made the colonizers wealthy).
However, the rise of capitalism that was followed by a gradual rise of
democracy failed to curtail the structural causes of income and wealth
inequality—the forces of wealth concentration. A much bigger impact on
leveling inequality in the 20th century was made by the two world wars, state
failures, and revolutions, given that a huge amount of wealth had been
destroyed and violently redistributed throughout Europe. It did not take long
for these trends to be reversed in the final two decades of the 20th century,
meaning that we are once again facing an issue of relatively high income
inequality, or in other words a level of inequality that the majority of society
no longer sees as fair and justifiable. The next chapter looks at the three
parallel trends that had happened in the 20th century: an emphatic switch to
democracies in the final decades of the 20th century, a consequential
expansion of the welfare state from the mid-20th century, and a simultaneous
increase of income inequality. It seeks to provide an answer as to why the
relationship between democracy and inequality is neither linear nor negative,
as it is often theoretically assumed. Then we will move on to the empirical
evidence of elite concentration among top corporate executives in Chapter 4.
 3
Democracy and Inequality in the Short Run

We must make our choice. We may have democracy, or we may have wealth concentrated in
the hands of a few, but we can’t have both.
—Louis D. Brandeis, United States Supreme Court Justice, 1916–1939

3.1. The Switch toward Democracy

Up until the 20th century and throughout history, the majority of countries in
the world were autocratic. As outlined in the previous chapter, the logic of
elite rule was heavily contingent on the context of an extractive autocratic
system. Today most countries in the world are democracies, albeit with vast
differences between them. Some democracies presume a constitutional
liberal order, while others descend into various forms of illiberal populism.
Some enact strong institutions and rule of law, others allow their institutions
to be captured by partial interests. Nevertheless, the trend even before the
fall of the Soviet Union has been clear. Since the 1970s until today the ratio
of democracies to nondemocracies has almost completely shifted. In 1970
over 70% of countries in the world were nondemocratic (a number that has
been consistent since the mid-19th century), whereas in 2020 almost 60% of
all countries were democracies (see Figures 3.1 and 3.2). Furthermore,
almost all rich countries in the world today are democracies (with the
exception of a few oil exporters), while the vast majority of poor countries
have some form of autocratic government.
Figure 3.1 Democracies, autocracies, and anocracies in the world, 1950–2020. Source: Polity IV Proje
ct, 2018. Democracies and dictatorships aren’t binary categories. There are many shades of gray
between the definitions of a fully consolidated democracy (such as the United States and western
Europe) and a hereditary dictatorship (such as North Korea). The Polity IV database ranks countries
from an index score of −10 (hereditary autocracy) to +10 (consolidated democracy). In the middle of its
ranking scale they define an anocracy, a political system characterized by economic and political
instability and inefficiency. In anocracies human rights are still endangered for various social groups
(religious, ethnic, sexual minorities, etc.), there is a lack of freedom of the press, there is considerable
violence and crime present (on average even more than in autocracies), but elections are allowed, as is
the multiparty system, and everyone in the population freely participates in elections. Although the
opposition exists it is often subdued by being forbidden from public speaking, it lacks media attention,
and there are often signs of elections being rigged. The best examples of anocracies would be Russia,
Turkey, Egypt, Venezuela, and Thailand in the recent decade, or Mexico before the 1990s.
Figure 3.2 Global regime change from 1950 to 2022. In 1950 only 24 countries in the world were
democracies, and three times as many were autocracies with a few anocracies and colonies. Africa,
Latin America, Eastern Europe, and a huge part of Asia (the Soviet Union included) were all under
some form of an autocratic regime. In 2022 the situation is radically different: the vast majority of
countries are democracies, with only a dozen autocracies and two dozen closed or open anocracies left
(mostly in Asia and parts of Africa). Source: Herre (2021).

The legacy of the Cold War era is a resounding victory not only for
capitalism over communism, but also for democracy over autocracy. The
introduction of both capitalism and democracy has been the dominant
political-economic transition many of the former autocratic socialist
countries have embraced. The transition from socialist autocracies to
capitalist democracies has brought ills as well as gains. While the
introduction of the market system has undoubtedly risen living standards, life
expectancy, wages, and incomes; improved the quality of public goods;
increased government efficiency and accountability; and improved human
rights standards throughout (obviously to a varying extent depending on the
country at hand),1 critics have pointed to rising social injustice, inequality,
poverty, and both economic and personal insecurity as obvious consequences
of the transition process.2 Many have struggled with the introduction of the
market system, the benefit of which has been captured by the well-entrenched
few (politicians and “the mafia”), rather than shared by the disenfranchised
many.3 Transitional countries have seen eroding trust as a consequence of this
process, where a significant amount of the population in each country has
been dubbed the “losers of transition.”4
On the other hand, a similar argument can be made in some Western
countries in the past 40 years. Rising inequality, lack of social mobility,
increasing sense of insecurity, depleting levels of trust, and an entire blue-
collar generation being proclaimed the “losers of globalization” are
contemporary issues in Western democracies that almost mimic the concerns
facing many transitional societies to date. Why have the ills usually
associated with transitional economies been so easily transferred to the West,
within countries which have strong institutional and constitutional rules that
should have prevented precisely these types of outcomes? Why has the West
failed to become fully robust to cronyism and interest group state capture?
 This chapter focuses on the two parallel trends that occurred in the West
in the second part of the 20th century (hence dubbed “the short run”): the rise
of government spending initiated by the expansion of the welfare state, and
the simultaneous rise of income and wealth inequality. It examines why
inequality failed to subside after one of the strongest periods of living
standard expansion and productivity growth (from the 1920s to the 1970s in
the United States and from the 1950s to 1970s–80s in Europe and Japan)
coupled with the rise of the welfare state.

3.2. The Relationship between Democracy and Inequality

The long-run switch to democracy unfortunately had no lasting impact on
reversing inequality trends. The rise of the welfare state, one of the most
significant sociopolitical outcomes of the 20th century, coinciding with the
rise of democracy and greater political representation, did not put a dent in
the forces of inequality, at least not as a long-term outcome. What we
observe today are much higher living standards than ever before. Economic
progress over the 20th century brought about incredible riches and
possibilities for newer generations to engage in occupations that their
ancestors could not even envision. This unprecedented economic progress
was driven, for the most part, by historically high productivity growth from
the 1920s to the 1970s (in the United States, and from the 1950s to 1980s in
Western Europe and Japan), an era during which wages for the low and
middle classes steadily increased.
Economic progress was undoubtedly followed by a rise in democratic
standards (more on this in Chapter 8). As shown in Figure 3.1, countries
were rapidly switching to democracies, but their democracies evolved
internally as well. Take the United States, for example. In the 1950s and
1960s, despite strong productivity growth and rising living standards, large
parts of the population, like women and African Americans, were partially
or fully excluded from this progress. The 1960s were a particularly turbulent
decade in the United States with mounting support for social change, which
suggests that despite seeing lower inequality in the numbers5 a lot of people
felt they were being excluded from progress. The civil rights movement,
originating a full 100 years after President Lincoln abolished slavery,
perfectly encapsulates the state of disenfranchisement of the African
American community, not only in the South, where they were treated like
third-grade citizens and were used as cheap labor, but also across the
country, where they struggled to move up the social ladder even with access
to higher education.
It was not until the mid-1970s and throughout the 1980s and 1990s that the
consequences of the civil rights movement and the women’s liberation
movement bore fruit and allowed the previously disenfranchised groups to
climb up the social ladder and yield high(er)-paying positions in the
corporate, academic, and public sectors.6 The emancipation movements were
not without problems. The 1980s and ’90s experienced issues of sexual
harassment at work, and had to feature affirmative action campaigns to
increase workplace equality (the rap and hip-hop culture of the 1990s
implies that the black community was still experiencing difficulties related to
poverty, violence, and crime). Even 40 years later, the highest ranks of the
corporate and even academic milieu were still dominated by white men.
Nevertheless, all of these changes were undoubtedly a significant
improvement over the supposedly low inequality/high social mobility era of
the 1960s.
American democracy therefore gradually improved over the decades of
its largest economic expansion. Even though disenfranchised and minority
groups gained more rights and were climbing up the social hierarchy, the
expansion of rights did not reduce the inequality trends of the 1980s and
1990s.
We must therefore ask ourselves, should there be any implicit relationship
between democracy and inequality? In one of the most famous papers on
political economy, Meltzer and Richard proposed a theoretical model in
which more democracy implies more redistribution and hence lower
inequality.7 In a typical societal income distribution curve, the median voter
is usually to the left of the mean income voter, which is always slightly tilted
to the right—meaning there are more poor people than rich people in a
society (see Figure 3.3). The larger the gap between the mean income voter
and the median population voter (i.e., the poorer the median voter), under the
assumptions of the Downsian model of electoral competition,8 more
redistribution will be demanded.
This unique theoretical proposition implies that more unequal countries
should have or strive for larger governments, as a result of the voters voting
for greater redistribution. This might have been true in the beginning of the
20th century, when most Western countries started introducing democracy by
expanding the franchise, which saw a corresponding increase of government
spending and revenues (see section 3.3). However, in the past 50 years both
the size of government and the levels of income and wealth inequality
significantly increased. Why didn’t the increase in government size, largely
attributed to the expansion of the welfare state, lower inequality as the
Downsian and Meltzer and Richard models suggest? Did the behavior of
well-organized special interests deplete the resources available for
redistribution to the poorer ends of society? Did democracy fail in its attempt
to lower inequality and provide the basic living standards for the poor? Or is
favoritism of the few at the expense of the many an inevitable outcome of a
democratic system?

Figure 3.3 The distribution of income in society. The x-axis represents income, while the y-axis
represents how many people there are for each distribution of income. Point m represents the median
income person, the person that splits the population into two equal halves, while μ represents mean
income. The distribution of income in society is never a normal distribution but is always right skewed
given that there are more poor and middle-income people than rich people in a society. Notice how in
any society the mean income is always greater than median income. According to Meltzer and Richard
(1981) the greater the distance between mean and median income, i.e., the greater the level of
inequality in a country, the more likely that a country will demand more government spending.
 Looking at the distribution of inequality across countries, there is no
consistent relationship between a democratic system of governance and the
Gini coefficient (Figure 3.4). The poorest and the most unequal societies in
the world today are predominately not democracies (or at least not complete
democracies), meaning that their ruling elites do not really care about the
position of the median voter. On the other hand, some of the countries with
the lowest level of inequality have a strong democratic tradition. There are
also so many exceptions suggesting the opposite: relatively unequal
democracies (like the United States or the United Kingdom), and relatively
equal autocracies or anocracies (like Singapore). Furthermore, the data does
not support the theoretical predictions that inequality in democracies should
be lower as the voters demand more redistribution. The models fail to
explain the long-term and short-term dynamics of inequality.
While it remains relatively easy to explain the persistence of inequality in
institutionally weak societies, the question remains: Why is the median voter
in the West still disenfranchised? Shouldn’t the persistence and consolidation
of democracy imply a gradual decline of inequality over the past generation?
Figure 3.4 Democracy versus inequality. The Polity IV democracy ranking is from -10 (autocracy) to
10 (democracy). Higher Gini implies higher inequality. The graph deploys averages of the democracy
index and the Gini since 1980 to 2020. Source of data: Gini: World Bank, https://data.worldbank.org/indic
ator/SI.POV.GINI. Democracy: Polity IV.

The empirical literature on the relationship between democracy and

inequality is vast but inconclusive.9 While earlier efforts were mostly cross-
sectional regressions linking inequality to democracy, some of them
emphasized that in order for inequality to decrease in a democracy enough
time has to pass for the democracy to consolidate.10 More contemporary
studies used a panel dataset to test the same relationship, but have found
varying impacts of democracy on inequality. While some authors confirm a
positive effect of democracy on lowering inequality,11 others find no
conclusive evidence that democracy lowers inequality.12 Most of the early
literature tends to suffer from endogeneity problems: the omitted variable
bias (a variable affecting both democracy and inequality that could be
driving the results) and the reverse causality problem (inequality leads to
democracy, not vice versa). Furthermore, the literature is mostly focused
around the initial impact of democratization on inequality, and how much
time it took for inequality to decline in a well-consolidated democratic
environment, a direction of research inspired by Kuznets’s theory of
inequality.13
Democratization arguably carried an additional effect on inequality, an
effect driven by the forces of wealth concentration and realized through the
rapid rise of interest group power. As interest groups in democracies become
better organized, they become more successful at increasing the size of
government, but bias that increase toward themselves. This leaves relatively
less money for redistribution programs aimed at the poorer ends of society,
particularly in terms of education and health care. Olson’s theory of
collective action explains this phenomenon where small (privileged) groups
possess enough information, have low enough organization costs, and are far
more homogeneous in distributing the potential benefits to successfully solve
the public good allocation problem.14 As the number of interest groups
fighting for state redistribution increases, this becomes a wider burden for
society, whose productive resources are being suboptimally allocated. The
phenomenon is called interest group state capture, and is unfortunately
characterizing more and more democratic societies today—both rich and
poor. The concentration of power among interest groups in democracies
epitomizes the internal logic of elite networks: small, privileged, well-
organized, with access to key information, and most importantly, with
proximity to power.

3.3. The Rise of Government Spending in Democracies

With the rising allure of democracy commencing in the 1970s, two other
trends originated at approximately the same time in the already-established
democracies of the developed world. The first was a significant rise in size
and scope of government (starting already in the mid-1960s for most
countries), while the second was an almost parallel rise in income inequality
(starting in mid-1970s and picking up pace after the 1980s). There is no
implied causal relationship, of course; however, it is puzzling that higher
government spending, driven primarily by an expanding welfare state, did
not, within a democratic setting, gradually lead to lower inequality. In other
words, the theoretical implication that democratization should over time
accumulate lower income inequality has not been backed up by empirical
evidence.
 Let us examine the empirics. Table 3.1 shows the size of government
spending as share of GDP for 16 selected developed countries, within and
outside of Europe, with averages for each group.15 Government spending
data includes only spending of the central government (excluding local
government and the rest of the public sector), and in this case it also excludes
interest payments on public debt.
Table 3.1 Size of government expenditure as share of GDP for selected countries, 1910–2010. Source:
IMF (2013) Dataset “Public Finances in Modern History” based on Mauro et al. (2013)
Country 1910 1925 1935 1950 1960 1970 1980 1995 2005 2010
Austria 17.3 13.7 17.2 26.2 36.3 39.5 50.1 56.3 49.9 52.5
Denmark 6.4 10.9 11.3 10.9 16.4 42.1 52.6 59.2 52.7 58.4
France 10.5 11.2 20.2 24.1 22.2 20.5 45.9 54.4 53.5 56.6
Germany 19.4 14.2 12.6 27.1 29.2 39.4 48.2 54.8 46.9 47.8
Ireland 18.3 21.7 25.8 29.1 44.1 53.7 41.3 33.7 46.8
Italy 13.8 11.4 24.5 17.3 18.2 32.3 40.7 52.4 47.9 50.2
Netherlands 10.2 7.6 11.7 23.9 20.4 43.1 55.2 56.4 44.7 51.2
Spain 9.9 11.8 13.9 11.7 11.1 13.9 21.4 44.4 38.4 45.6
Sweden 8.5 9.5 12.1 18.2 24.4 29.5 41.1 64.9 53.8 52.8
Switzerland 4.1 4.2 6.2 8.5 7.1 25.7 29.9 35 35.2 34.1
United Kingdom 8.2 18.1 19.4 32.6 33.1 42.1 47.6 43.9 44.1 50.5
Average Europe 10.8 11.9 15.5 20.6 22.5 33.8 44.2 51.2 45.5 49.7
United States 2.2 3.2 10.1 14.7 28.2 32.3 34.2 37.1 36.3 42.4
Canada 6.1 7.1 12.4 14.9 30.6 36.1 41.5 48.5 39.1 43.8
Australia 2.6 4.3 5.4 12.2 21.8 25.3 33.2 36.8 33.9 37.1
New Zealand 13.5 17.7 17.9 21.8 25.3 24.8 38.1 33.4 29.7 35.1
Japan 3.1 2.1 3.5 15.8 18.3 20.2 33.4 34 34.2 39.8
Average Non-Europe 5.5 6.9 9.9 15.9 24.8 27.7 36.1 38 34.6 39.6

Figure 3.5 presents the full trend of government spending over the past
century for the same group of countries, while Figure 3.6 presents the same
long-term trend for central government revenues (also excluding local
government and the rest of the public sector).
Figure 3.5 Central government spending to GDP for selected developed countries, 1900–2010. Source:
IMF (2013) Dataset “Public Finances in Modern History” based on Mauro et al. (2013).

The overall trends are clear. There has been a significant increase in the size
of government in the past century among the world’s richest democracies, in
most cases increasing rapidly after World War II, particularly in the 1960s
and 1970s. This growth in the size of government has slowed down during
the 1980s, peaked in the mid-1990s, and slightly regressed in the early
2000s, only to increase once more as a consequence of the 2008 financial
crisis (fiscal stimuli and bailouts as an immediate response to the crisis).
The growth in both government spending and revenues (Figure 3.6) exhibits
the same pattern, except for the post-2008 crisis years where the rise in
government spending overtook that of revenues, leading to increasing budget
deficits in many developed democracies, all of which acted as a trigger for
austerity policies starting in 2010. Interestingly, European countries have,
throughout the observed 110-year period, had on average higher levels of
government size than non-European countries.
All of these trends are expected. The beginning of the 20th century was
characterized in most part by a laissez-faire approach to the role government
in the economy, limiting its size and scope significantly, and limiting tax
revenues to tariffs and duties. The interwar period introduced first social
security systems, while the onset of the Great Depression gave further rise to
the scope of government intervention in the economy, almost doubling it in
size by 1937. In countries that descended into fascism (Germany, Italy) the
national-socialist model rested on an encompassing role of the state with an
aim to allocate resources into the war machine. The size of government
doubled in those countries in the interwar period.

Figure 3.6 Central government revenues to GDP for selected developed countries, 1900–2010. Source:
IMF (2013) Dataset “Public Finances in Modern History” based on Mauro et al. (2013).

The post–World War II period was characterized by the dominance of the

Keynesian economic consensus. The welfare state started expanding rapidly,
as did all other forms of government intervention in the economy. Tanzi and
Schuknecht attribute this rise of government spending to the battle of ideas
over the role of government in the economy.16 In economic theory the
dominant paradigm was that of welfare economics,17 which revolved around
a social welfare function and having the state as the perfect social planner
that maximizes social welfare by efficiently allocating, redistributing, and
stabilizing the economy.18 The role of the social planner was to prevent the
re-emergence of structural factors that contributed to the Great Depression
and its subsequent outcomes, unemployment in particular. Hence the desire of
Western policymakers to adopt traditionally socialist policies, and to
promote the idea of a mixed economy transcending beyond pure socialism
and pure laissez faire.
Social security programs expanded the most during the postwar period as
they gradually started to turn into modern welfare states.19 This was
happening all across the Western developed democracies, transcending party
lines. In the United States, Social Security was established as part of
President Roosevelt’s New Deal in 1935, but it was the Republican
government of Dwight Eisenhower that expanded Social Security and
continued all the major New Deal programs from the Roosevelt
administrations. Medicare and Medicaid were both introduced later during
Lyndon Johnson’s Great Society program. In the United Kingdom, the
postwar Atlee government created the UK welfare state; they introduced
national insurance; founded the National Health Service (NHS); introduced
public housing, family allowances, and planning laws; improved worker’s
rights; and even nationalized industries. Other European countries followed
in the exact same way: Germany established the social market economy, very
similar to the Nordic model of social democracy combining a market
economy with a strong welfare state; France enacted its social protection and
welfare state system immediately after the War, as did the Netherlands and
many other countries throughout Europe (some sooner, some later), but also
beyond Europe (such as Canada, Australia, New Zealand, and Japan). It was
therefore no surprise to witness the significant expansion in the size of
governments in the postwar period. The role of the state in the economy
changed and modern welfare states were created.
Based on skepticism toward government intervention in the economy, the
1980s delivered political change characterized by a reduction in the scope of
government intervention and a slowdown in the growth of government size.
The dominant Keynesian economic consensus was disrupted through three
major developments, one of which was external: in the 1970s the West was
faced with a major oil shock. This was a direct consequence of political
instability in the Middle East driven by the Yom Kippur War, after which
Arab oil producers decided to cut supply and hence increase oil prices as a
political lever against the West. The second development was the shift in the
intellectual battle of ideas. The monetarist tradition of Milton Friedman, the
rise of public choice theory, and the recognition of Hayek’s work with a
Nobel prize in 1974 convinced many that governments can fail too, and that
they are not necessarily the benevolent social planner they were assumed to
be.20 Hayek, Friedman, and the Chicago School economists provided
intellectual ground for the policies enacted by the new Thatcher and Reagan
governments in the United Kingdom and United States. The battle of ideas
shifted against big government and the Keynesian paradigm. The third factor
that made the switch was the 1970s stagflation, a phenomenon of
simultaneously increasing inflation and unemployment, which was
inexplicable by mainstream economic theory at the time. Given the success of
the Thatcher and Reagan administrations in reigniting economic growth in
their countries, the new economic mainstream consequentially inspired
policy changes throughout Europe and beyond, with varying interpretations
and consequentially with varying rates of success, particularly when it came
to transitional postcommunist economies and the countries of Latin America.
Market reforms and privatization projects did commence in the 1980s, but
their effects were not fully apparent until the mid-1990s, which is why it is
not surprising to see government size peaking in the mid-1990s. Thatcher’s
and Reagan’s governments’ legacy was given further momentum by the fall of
communism, as even their political opponents (Democrats in the United
States and New Labour in the United Kingdom) continued with promarket
reforms reducing both the scope and size of government. This decrease in
size was, however, only marginal overall (from an average of 50% down to
45%), bringing the size of government back to its 1980 levels by 2005. After
the 2008 crisis, the size of government increased once again, mainly as a
result of countercyclical fiscal policies implemented during the onset of the
crisis. The United States and many European countries engaged in massive
bank bailouts to prevent further panic on the markets and a potential new
depression (or at least, that was the prevailing narrative), and have
subsequently continued with large fiscal stimuli designed to initiate a
stronger recovery. The politics of austerity did not start until 2010 in most
countries, primarily as a response to a rapid increase of public debts and
deficits, in most cases attributed to the initial responses to the crisis.
However, even with austerity policies the size of government did not go
down by much at all. Then in 2020 we received a stimulus package on
steroids as a response to COVID-induced lockdowns, bringing government
size (and levels of public debt) to historic highs.
The data on government size can only tell us so much. A more interesting
story is to uncover the scope of government, or in other words, the
composition of government spending. According to Tanzi and Schuknecht,
during the post–World War II period all OECD governments experienced a
rapid increase in government spending on subsidies and transfers, mostly due
to an expansion of the welfare state. On average total spending on subsidies
and transfers (entitlements) went from a mere 4.5% before the war to 23.2%
in 1995, an increase by a factor of five. Social expenditures on health,
education, and pensions explain the majority of this increase (Figure 3.7).
Education and health spending went from 2.1% and 0.4% before the war to
6.1% and 6.4% respectively in the mid-1990s. Unemployment insurance and
other income transfer programs remained mostly marginal parts of the
budgets throughout. The category that expanded the most in this period were
pension expenditures. They went up from 1.9% prewar to 9.6% in the mid-
1990s. The rapid expansion of both pensions and public health expenditures
were a natural outcome of an aging population, but it was a policy decision
of solidarity that made these programs possible and indeed achievable.21
Other spending categories mostly remained relatively stable throughout.
Defense spending peaked during the Cold War, but never went past 4% and
gradually declined to less than 2% over the past 20 years. Spending on
public investment has mostly circulated between 3% and 4% during the
entire period. However, spending on interest on public debt has quadrupled
since the 1970s (corresponding to the trend of rising public debts in the past
four decades22). It went from a mere 1.4% to 4.5% in 1995, and over 6% in
2010.23 Such dramatic increases have understandably caused fiscal
instabilities in many countries, particularly after the 2008 crisis.
Figure 3.7 Education, health, and pension spending from 1937 to 1995. Entitlement spending over the
past 70 years increased rapidly primarily in these three categories. Source: Tanzi and Schuknecht
(2000).

Finally, governments expanded not only in their programs but also in their
services, which needed to be properly administered. The expansion of the
bureaucracy was thus far from surprising. The size of public sector
employment in total employment went from 5.2% before the war to 18.4% in
the mid-1990s (Figure 3.8). Public sector wages thus became the second-
biggest expenditure category, after social expenditures, in almost every
developing economy.24
All the reported numbers are averages across the developed countries,
and while there exists considerable variation between countries on each
particular category of spending, the trends are the same for all, just as they
have been for the growth of government spending.
To conclude, government has steadily increased in size throughout the past
60 years, while also changing considerably in structure and hence scope.
This trend has been slowed down from time to time, but it is a trend that
undoubtedly shows how in contemporary societies the role of government is
as important as it has ever been. The post-COVID fiscal and monetary
response exemplifies this better than anything.
Figure 3.8 Total spending on subsidies and transfers (social spending), and the share of public sector
employment in total employment. Source: Tanzi and Schuknecht (2000).

3.4. The Rise of Inequality in Democracies

One of the first questions that come to mind while going through the spending
numbers is, Have the governments been successful? Has an increase in
government size and scope made the difference it was supposed to make?
Did it make people healthier and more educated? Did it decrease
unemployment and smooth out economic shocks? Did it provide the
necessary infrastructure and public goods? And finally, did it decrease
poverty and the rates of economic inequality? In other words, how good was
government performance of its three main Musgravian functions: allocation,
redistribution, and stabilization?
While unemployment, inflation, and deficits are cyclical categories for
which we cannot make any plausible inference, data on health, education, and
inequality do tend to show sensible trends over time. Infant mortality
dropped significantly, life expectancy increased throughout, average years of
schooling doubled, illiteracy rates are down to almost zero, pensions
dramatically reduced poverty among the elderly, and poverty overall has
declined as well.25
It is obviously difficult to claim a causal relationship between the role of
government and any of these trends, nor do I intend to engage in such a
debate. However, one particular trend does stand out, stubbornly defying
expectations in light of evidence of an expanding welfare state—the rise of
income inequality.
Figure 3.9 testifies to an increasing trend in gross earnings of the top
decile of the population (top 10% income earners) as compared to the
median income earners for selected developed countries, starting by the end
of the 1970s, with the exception of France, which has not experienced a
relative increase of top earnings at all, and Japan, where inequality did not
start increasing until the 1990s. Atkinson suggests that the distribution (or
dispersion) of earnings is the most precise measure of income inequality as
it captures only the differences in earned incomes (as opposed to capital,
rents, transfers, etc.) and it focuses on the relative performances of top
income earners compared to the rest of society (this way it accounts for the
fact that some people do indeed deserve higher wages due to their greater
job responsibility or risk). If the growth of income among the top 10% of
earners outpaces the growth of the median income in the population,
inequality goes up.26
Figure 3.9 Gross earnings at the top decile as % of the median for selected developed countries, 1945–
2013. Source: Atkinson et al (2017) Chartbook of Economic Inequality. Countries with an asterisk (*)
have two different series merged into one.

Before drawing out even remote implications, one should note that
earnings data is not perfectly comparable between countries. This is mainly
because of different ways of defining and reporting income and earnings
across countries, particularly over time.27 However, in this particular case
the point of interest is the trend within each country, and whether such trends
of a rising dispersion of top incomes happened in other rich democracies at
the same time. The point is therefore not to show that earnings at the top grew
higher in the United States compared to other countries, or to point out the
differences in levels of earnings across countries, but only to imply a general
trend where top earnings relative to the median increased in the past 30–40
years for the entire observed, yet deliberately limited, sample.
The short conclusion is: they have. This has been well established in the
literature for each of the countries used in the sample. Atkinson offers the
most detailed summary of inequality trends across 20 OECD countries. He
finds that over a period of 25 years, from the 1980s to 2014, only France and
Ireland have seen a significant (over 10%) growth in incomes of the bottom
earners that has outpaced the growth of the top decile earners. All other
countries have experienced high growth rates in top decile incomes coupled
with either modest or declining growth rates of the bottom deciles. In the
United States for example, top decile incomes increased by 15%, while
bottom decile incomes fell by 5%. Similar trends, although with a lower
magnitude in both directions, occurred in the United Kingdom, Netherlands,
Sweden, New Zealand, and Australia, while other countries all experienced
much higher growth rates in earnings of the top decile compared to growth in
earnings of the bottom decile. Atkinson also points out that inequality in the
dispersion of earnings mostly originated because of changes in top incomes,
a trend that coincided in almost all observed countries.28

Figure 3.10 Gini coefficients for equivalized household gross income, for selected developed countries,
1945–2013. Source: Atkinson et al (2017) Chartbook of Economic Inequality. Countries with an asterisk
(*) have two different series merged into one.

The Gini coefficients, a standardized measure of overall inequality shown

in Figure 3.10, indicate a similar trend as do the earnings numbers from Figur
e 3.9. Across the observed sample inequality started going up since the
1980s onward, with the average increase across the sample being around
five percentage points (excluding the United States and the United Kingdom
the average increase is still high—around four percentage points).
The Gini index is designed to be more comparable across countries,
meaning that we can make inferences of how the United States is a
particularly interesting outlier in the developed world with significantly
higher inequality than the rest of the sample. On the other hand, the United
States has throughout history always had higher inequality than European
countries, persistently trading off inequality for efficiency. Back in 1975, in
the midst of a decade of historically low levels of inequality in the United
States, when average top income taxes were 75%, Arthur Okun still reports
“alarmingly” high inequality in the country: “The richest 1 percent of
American families have about one-third of the wealth, while they receive
about 6 percent of after-tax income. The bottom half of all families hold only
5 percent of total wealth.”29 Today this figure is even higher for the richest
1%, holding around 18% of total income, and about the same in total wealth.
The “cut-throat” model of US capitalism based on an innovation-driven
economy versus the “cuddly” European capitalism30 will always imply
greater relative inequality in the United States. The issue therefore, once
again, is not in the relative differences between countries, but in the trends
pointing to the same direction. Income inequality has been steadily increasing
throughout the rich, developed democracies, with only a few exceptions.
It should be noted that the data for individual countries reports an increase
of inequality measured by any indicator used. The Chartbook of Economic
Inequality database31 contains indicators of top 1% and top 0.1% of income
earner dispersion but also indicators of wealth inequality and poverty.32
Figure 3.11 presents the trends of an increase in inequality at the very top
of the income distribution: Piketty’s supermanagers. The share of top 1%
earners’ income in total gross income has seen two major trends in the 20th
century—a gradual decline from the beginning of the century culminating in
World War II (confirming Scheidel’s argument that wars tend to be great
equalizers), followed by a 30-year relative33 stagnation and a major
resurgence since the mid-1980s. It should be noted that the resurgence trend
is mostly driven by Anglo-Saxon countries; United States, United Kingdom,
Canada, New Zealand, and Australia. However, all other countries have also
experienced an increase in the share of top 1% earners’ income, albeit much
smaller than in the aforementioned countries. The average increase in
inequality, measured through the share of top 1% income growth, was 55%
from 1980 to 2008 for the entire sample (shown in Figure 3.12). But when
dividing it between Anglo-Saxon and non-Anglo-Saxon countries the
difference is clear: the average increase in inequality in the former group of
countries was over 90%, while in the latter group it was 33%. Two countries
that particularly stand out are the United States and the United Kingdom with
an average increase in top 1% inequality of 130% over the past 30 years.
The trend across all countries supports Piketty’s supermanager argument: the
rise of income inequality was primarily due to the rise of corporate executive
earnings (the majority of those in the top 1% of earners).

Figure 3.11 The rise of the supermanager, exemplified by the increase in the share of top 1% earners’
income in total gross income from 1900 to 2013. A share of 18%, for example, in the United States
implies that 1% of top income earners captured 18% of all total gross income. Countries with an
asterisk (*) have two different series merged into one. Source: Atkinson et al. (2017) Chartbook of
Economic Inequality.

While all income indicators suggest the same conclusion of increasing

income inequality across the developed world, poverty indicators paint a
somewhat different picture. On average across all countries, poverty levels
have, since the War, dropped down from above 30% to slightly below 13%
by the early 1990s, but have since then started to gradually increase. For
some countries the rise in poverty exacerbated after the financial crisis of
2008, bringing the average poverty levels across the sample back to an
average of around 17%. However, this increase has been much lower than
the corresponding rise in earnings inequality, reinforcing the notion that the
main culprit for the rise of income inequality has not been a decline of
bottom incomes, but rather a rapid rise of top incomes. Finally, wealth
inequality also experienced a steady decrease since its high prewar levels
across the entire sample (wealth was always much more concentrated than
income, so wealth inequality levels were historically always higher than
income inequality), and has for most countries evened out and stagnated in
the past two decades. In the United States and the United Kingdom however,
according to some measures, wealth inequality has in the same period again
started to slightly increase.

Figure 3.12 Average increase in inequality from 1980 to 2008 when measured as the share of top 1%
earners’ income in total gross income across the sample of 13 chosen countries. Source: Atkinson et al.
(2017) Chartbook of Economic Inequality.

To sum up, two very interesting trends occurred simultaneously over the
past 60 years. There was a continuing expansion in government size—its
expenditures, revenues, social spending, public debt—a trend that started in
the 1960s, peaked in the mid-1990s, declined slightly afterward, and has
again started rising after the 2008 crisis. During the same period, originating
after the 1980s, there was a significant increase of income inequality, mostly
driven by large increases in incomes of top earners (1% and 0.1%). There is
hardly any causal inference to be made at this point, but the trend of rising
inequality does pose a question on the predictions of classical political
economy models on the relationship between democracy and inequality.
What could have been the reasons behind this? Did the behavior of well-
organized special interests deplete the resources available for redistribution
to the poorer ends of society by channeling excess government spending
toward themselves? In other words, has the expansion in government size
been tilted toward narrow groups with more power, thus creating a rent-
seeking society? Is favoritism of the few at the expense of the many an
inevitable outcome of our political system? In order to shed a new light on
these questions, we need to implicate politics and understand the role of
political decision-making in shaping economic outcomes. But before that, it
will be useful to survey the numerous empirical studies done by economists
to uncover and understand all the economic factors that could help explain
the rise of income inequality.

3.5. Economic Explanations of the Rise of Inequality

According to Atkinson, Piketty, and Saez, annual average real income growth
for the bottom 99% of income earners in the United States was only 0.6%
over a period of 40 years (from 1976 to 2007). In the same time, incomes for
the top 1% grew at an annual rate of 4.4%. Most of this income growth did
not come from salaries (even though their growth was also substantial), but
from things like capital gains and business income (investments, dividends,
business profits, etc.) This long-run trend led to massive accumulation of
wealth at the top, where the top 10% of income earners earned 47% of all
income in the United States, while the top 1% earned about 19% of all
income34 (their share has slightly declined as an immediate consequence of
the financial crisis, but has continued to expand since). Even though the
United States is an outlier among rich democracies, similar trends of rising
incomes at the top and stagnating incomes at the middle and the bottom
happened all across the West.
Why have real wages stagnated particularly among the lower income
groups and the middle classes, while income earnings at the top grew
rapidly?
Economists have provided a number of explanations. The most usual ones
are the impact of education, technology, and globalization. Technological
progress in the past 30 years was attributed to the IT revolution (which many
call the Third Industrial Revolution), and has been tilted in favor of those
with greater skills and better education. Economists call this the skills-based
technological progress hypothesis,35 fully capturing the creative destruction
impact of technology on jobs and wages. The supply side has adjusted to this
change. More and more people started getting better education across the
developed world. University enrollments as well as the share of people with
a university degree are substantially higher in every rich democracy
compared to pre–World War II levels. The skills premium, according to
which greater education implies better paying jobs, has made a further dent
in the divergence between top and bottom incomes, which are becoming
clustered with respect to attained education levels.
Globalization was another important factor. The rise of China and the
supply chain economies of East Asia have created an outsourcing trend
where low-skilled manufacturing jobs in the West were being shifted to low
labor cost Asian countries. Free trade created clear winners and losers from
globalization. Domestically, immigration took the rest of the low-skilled
jobs, pushing the labor market equilibrium toward lower wages. The low-
skilled, poorly educated blue-collar workers who could not adjust faced
either long-term unemployment or a significant cut in their incomes by
accepting jobs in the emerging services industries, which paid less than their
former manufacturing jobs.36
Economic theories do recognize the importance of certain political factors
that depressed low and medium-income earnings. Minimum wage laws,
always a controversial political issue, have not followed inflation trends,
thus further depressing real wages of the poor. Changes in tax codes became
less progressive over time, and opened up new opportunities for wealthier
citizens to shift their wage incomes into things like capital gains. This
consequentially increased the share of capital and decreased the share of
wages in total national income. On the other hand, transfers to the poor
became more streamlined toward groups with more political power (such as
the elderly). Atkinson also cites various cuts in welfare state programs
throughout the 1980s and 1990s, leading to a scaling back of the welfare
state, rising levels of long-term unemployment, rising interest rates on student
loans, and of course the declining bargaining power of labor unions
(membership in unions, particularly in the private sector, fell drastically
since the mid-1970s).37 Deaton adds to this the gender wage gap, which
particularly affected single-mother households, and the fact that poorer,
nonvoting immigrants are not politically represented well enough to
successfully fight for more redistribution for themselves.38
On the other hand of the spectrum, positively affected by most of these
changes, were the top income earners. As emphasized earlier, the rise in
earnings dispersion came primarily as a result of higher growth of top
incomes, mainly through higher gains from capital investments, dividends,
and business profits (for innovative entrepreneurs). The high-skilled,
innovative part of the economy received their rewards. Emerging billionaires
in the tech sector created new jobs and entirely new industries. The problem
was that such industries required a high-skilled workforce and could not
replace the jobs lost due to outsourcing, at least not for the same people.
While the tech sector captured most of the innovation-led growth, other
industries turned toward trade and managed to achieve large economies of
scale operating multinationally.
This could explain the exponential growth of CEO incomes (both their
salaries and their capital gains), the competition for which was no longer
local or national, but global. Gabaix and Landier have directly linked this
expansion in firm size to CEO pay. They found that, since the 1980s in the
United States, a sixfold increase in CEO pay can largely be explained by the
sixfold increase in market capitalization of the biggest companies.39 An
increase in industry concentration40 surely contributed to this effect, as large
firms became even larger, increasing the bargaining power of their CEOs in
demanding greater compensation. As some CEOs secured higher
compensations, the contagion effect made sure that other firms also raised
salaries for their CEOs in order to attract similar high-quality candidates or
risk losing their best people to the competition.
The multinational orientation of US firms can explain even the within-firm
differences where workers get paid the local rate of their city labor market
while CEOs get paid the global rate in the market for top talent. A similar
logic is at hand for earnings of other superstars, either in sports or show-
business. High demand for top quality talent, either by spectators or
shareholders, combined with extremely scarce skills will make sure that
earnings of superstars keep on rising. However, in some industries the
superstar effect seems to be clouded by luck. In finance the best example are
bonuses given to high-performance employees as a consequence of high stock
market returns. Kahneman showed that there was no consistency in year-to-
year rankings of top performers in the stock market within financial firms.41
In other words, finance companies were rewarding luck instead of skills. A
similar phenomenon occurs with CEO rewards in the oil industry. An oil
shock that pushes oil prices up and has nothing to do with individual skills of
a CEO (usually triggered by political or exogenous market factors) will still
deliver a large bonus to that CEO.42
Another factor could have been policy changes. Extensive countrywide
research conducted by Piketty, Saez, and Stantcheva suggests that tax policies
since the 1980s have been a major contributor to the rise of inequality in
OECD countries. They find a strong negative correlation between top tax
rates and top 1% income shares, meaning that top rate tax cuts since the
1980s in selected OECD economies impacted the rise of top income shares.
Furthermore, when top marginal tax rates fell, they’ve increased the
bargaining power of top executives vis-à-vis their boards, thus increasing
their total compensation. The bargaining effects were the key factor in
explaining inequality at the very top.43
Frequent changes in the tax code, instead of solving the issue typically
only add to its complexity. In almost every country the tax code is
deliberately cumbersome, with so many exceptions and potential loopholes
that are typically only exploited by those with privileged access to
information and resources necessary to seize the loopholes. Complexity
exacerbates inequality because the poor and middle classes lack the
resources to exploit tax loopholes and end up paying a disproportionate
burden.44 This is part of a wider trend of increasing policy complexity in
general, particularly since the second half of the 20th century, epitomized by
a significant increase of regulators and lawyers and the buoyant bureaucracy.
45 As technological progress makes societies exponentially more complex,

there is an increasing, yet futile, necessity to regulate everything. The typical

regulatory responses to economic and social complexity, other than always
being introduced ex post, can also produce adverse effects by increasing
informational asymmetry to benefit those close to the decision-makers.
Fukuyama sees this as one of the key issues of US political decay, as
domestic political institutions are becoming more susceptible to usurpation.46
Informational asymmetry arising from policy complexity further restricts
access to opportunities, adding to the inequality problem.
 Inequality is typically portrayed as a within-firm phenomenon, where
widening disparities in earnings between the executives and the workers act
as the main driver of income disparities. However, in a recent paper, Song
and his colleagues use microlevel data for the United States and find that the
inequality effect, particularly among the bottom 99% as well as for the
majority of the top 1% (except those in the top 0.02% of earners), is more
likely to arise between firms, rather than within firms. The reason for this is
clustering of high-paid workers in bigger and more successful firms, and
low-paid workers in smaller and less successful ones.47 This is confirmed by
Autor and his colleagues, who find that the biggest firms, the so-called
superstars (like Big Tech) act as the main driver of compensations at the very
top.48
The concentration in firm power and by extension executive compensation
is nowhere more obvious than in finance. The individual elite networks
drawn in Chapter 1 all originate from the finance industry, the expansion of
which has been unprecedented since the 1980s, as have the salaries of their
top executives. Research has shown that finance employees get 50% higher
earnings in the United States compared to their nonfinancial counterparts,
while the wage premium for top finance executives is 250% compared to
nonfinance top executives.49 This trend of divergent wage premiums for
finance versus everyone else started in the 1990s and has continued to
increase steadily over the next 20 years. It is hardly surprising therefore that
14% of the increase in the US Gini index since the 1990s can be attributed to
executive incomes in finance.50 In the United Kingdom, research has shown
that finance industry employees, which constitute around 5% of the entire
workforce, captured 60% of all growth in top incomes from 1998 to 2008.51
Even in France the same trend is noticeable since the mid-1990s, despite
finance not having such a prominent role as in the United States or the United
Kingdom. About half of the increase of the top 0.1% of incomes was
captured by people working in finance.52
These effects are hardly surprising when taking into account the
significant expansion of the finance industry and its contribution to GDP in
many countries worldwide. In the United States, its share of GDP has
increased from 4.9% in 1980 to 8.3% in 2006, growing at a much faster rate
than in the previous 30 years.53 This growth in earnings has mostly been
captured in asset management and household credit provision (specifically
mortgages). In other words, housing loans pooled into various types of bonds
and bond-backed derivatives, repackaged and resold to various asset
managers and big banks (the culprits of the 2008 financial crisis). As finance
captured a larger part of economic growth, it is no surprise to see salaries
going up across the industry, especially for its top executives.
The rising power of finance was not only an issue in developed countries,
but carries an impact on developing countries too. A study has found that the
most unequal developing countries face further constraints from special
interest capture and high barriers for access to finance. Specifically, the
political and corporate elites (i.e., elite networks) capture financial
liberalization reforms so as to divert access to finance for themselves, while
entirely socializing their risks. Unequal access to politics leads to unequal
access to finance, which skews the distribution of opportunities, and by
extension incomes and wealth. As a consequence, this creates further
political backlash against any kind of reform, pushing such societies further
down the negative feedback loop.54 Think of the privatization scandals in
transitional Eastern Europe or Latin America and the huge negative
perception their domestic populations have against reforms like
privatization. Privatization schemes across transitional economies were
typically organized to favor entrenched domestic elites close to politics, very
often originating from the old regime elites.55 In developing countries
therefore, the capture of financial institutions by elite networks is the main
mechanism through which the elites exacerbate inequality. This is becoming
an ever more prominent trend in developed countries as well. It is a natural
consequence of expanding elite network power.
To sum up, the economic culprits for higher inequality can be found in the
interaction of several factors. Rapid technological progress in the past 30
years resulted in a typical creative destruction process where new jobs and
careers made certain types of old jobs obsolete (automated work). Some of
these obsolete jobs were outsourced to Asia, others either did not re-emerge
or were limited to low-skilled immigrants. The low-skilled workers failed to
adapt to the changes and were left stranded either at lower paid jobs or
became long-term unemployed. Poor education played an important role,
while stagnating wages in the “dying” sectors only widened the gap. On the
other hand, the innovative part of the equation was working quite well taking
advantage of the new technological wave, thus further raising the income of
the top 10% and the top 1% (hence the great disparity between college and
non-college-degree workers). It is not hard to imagine how these two forces,
one pulling the low-skilled downward, the other pulling the high-skilled
upward, widened the income inequality gap in the West.
However, the standard skills-based and globalization and technology
hypotheses explain only one part of the rise in unequal incomes. They are
insufficient to explain the drastic changes at the very top of the income
distribution. First and foremost, all developed countries experienced the
same impact of better education that improved skills, and a similar impact of
globalization and new technologies, but only some saw a huge rise in top 1%
incomes. These were societies which obviously had a higher share of the
largest global corporations, the superstar firms. Furthermore, sectors in
which superstar firms are becoming more and more concentrated—like the
finance industry—are seeking to preserve their status mainly through the
political process. An obvious way is through lobbying and campaign
spending, but a much more subtle and effective way is through elite networks,
where corporate executives befriend politicians, who become more reluctant
to pass legislation that hurts their friends’ cause.
It is important to note here, as shown in Chapter 7, that industry
concentration is another artifact of rent-seeking firms preserving their status
through political connections. While the increase in firm size can be a good
explanatory factor of the rise in wages, and while an increase of firm
concentration and the rise of superstar firms adds to that effect where their
top corporate executives are being paid higher salaries, the missing link here
is the political connection these firms needed to have to allow such
concentration and subsequent rise and preservation of corporate power.

3.6. Political Factors That Could Help Explain the Rise of Ine
quality
In addition to the innovative and superstar part of the top 1% (and a few
lucky ones), there were others who instead of working for their wealth either
inherited it or have benefited from the political system of capturing rents.
Stiglitz refers to them as rent-seekers, those who receive “income not as a
reward for creating wealth but by grabbing a larger share of the wealth that
would have otherwise been produced without their effort.”56 The problem is
that even though the economic pie is growing, an even bigger amount of that
pie is being captured by rent-seekers instead of wealth generators, which
could be a potential culprit for inequality. Furman and Orszag cite an
increasing concentration of high returns among the most profitable firms
which all consequentially pay the highest salaries and drive the between-firm
inequality in earnings. Most of these concentrated returns are not based on
innovation, leading them to conclude that the returns could be a result of rent-
seeking.57 Lindsey and Teles suggest that high levels of industry
concentration, an increasing importance of intangible assets in corporate
balance sheets, and growing barriers to entry in many industries all point
toward increasing rent-seeking that is driving up inequality.58
While all these authors are referring to the United States, Svejnar and
Bagchi examine the hypothesis worldwide. They find that in countries where
billionaires made their fortune thanks to political connections allowing them
to control and build monopolies, the effect of their accumulated wealth and
the consequential income inequality on economic growth is extremely
negative. In cases where the billionaires weren’t politically connected there
is no effect between inequality and growth. Also, more unequal countries,
where individual fortunes are conditioned on political connections, are all
characterized by high levels of corruption.59 Corruption and political
connections tend to go hand in hand. And they seem to be pulling inequality
with them.60
Hence the importance of politics in explaining the phenomenon of rising
inequality. If the political system is captured by crony rent-seeking elites who
make sure that the gains from economic growth are limited to the selected
few, if the majority of the population believe that the system is skewed
against them (“rigged”) and that even in their greatest effort they still cannot
move up the social ladder or even escape poverty, this will fuel anger and
create political discontent. One direct and noticeable consequence of this
across the West has been the ascent of extremist populist political parties,
feeding on the justified anger of disenfranchised voters.
Consider again the example of the finance industry. It is no surprise to
learn that banking in particular has been very effective in using campaign
expenditures, lobbying, and their accumulated political influence to guide
regulatory decisions, block unfavorable and get favorable legislation passed
in Congress, and as a consequence achieve abnormal market returns.61 In
fact, banks with greater lobbying expenditures were shown to be taking on
more risk, particularly prior to the recent mortgage crisis,62 while greater
political influence clearly helped some banks secure much better bailout
deals.63
The main issue with such activities of the finance industry is that lobbying
done by banks to save themselves imposed a huge cost on taxpayers. This
happened in Europe as much as it did in the United States. The consequence
was a sovereign debt crisis as European countries massively accumulated
debt to save systemically important banks from bankruptcies, thus imposing a
double cost on taxpayers when it came time for harsh austerity measures to
address the debt and deficit issues. These activities have increased both
inequality and government spending.
The problem therefore is that lobbying activities of one powerful group
(even if done on an individual firm-by-firm basis) have imposed direct costs
on the rest of society. In the fight for government redistribution the well-
organized and the powerful groups will prevail. This goes beyond individual
industry examples. A number of papers confirm this effect, where greater
lobbying expenditures enable interest groups to get a large part of the budget
in several countries.64
To illustrate how this works, consider the example set out by Deaton on
poverty rates in the United States.65 Poverty trends have genuinely been
favorable in the United States ever since the 1960s. They have experienced
steady declines for all social groups, the old, the young, the African
Americans, and all minorities. In the 2000s, even prior to the crisis, poverty
rates for all groups have started to slowly increase, except for one group—
the elderly (to be exact, all those over 65 years of age). The reason the
elderly were the only group that experienced a consistent decline in poverty
rates, down to 10% according to the official Census data,66 is entirely
attributed to the success of the Social Security (Medicare) program for
senior citizens. And why has the Social Security program been so successful
for citizens over 65? Because their interests are being protected by one of the
most powerful lobby groups in Washington, the AARP (formerly the
American Association of Retired Persons). The AARP has consistently been
ranked among the top three most powerful interest groups in America by the
Fortune’s “Power 25” interest groups ranking,67 and it has spent over $260
million on lobbying to Congress since 1998.68 Its lobbying efforts have
certainly paid off as its members have enjoyed a better standard of living and
lower poverty rates compared to all other groups. Lowering poverty and
improving living standards of senior citizens is certainly a commendable
effort; however, the problem is that when one group successfully diverts
budgetary resources toward their own interests, it manages to do so at the
expense of all the other groups dependent on public funding. In other words,
successful political lobbying from the AARP for its members lowers the
funds available for all other groups that are becoming more exposed to the
risk of poverty.
Political scientists have uncovered a myriad of ways special interests
tend to capture the political system. Some of them link this directly to
inequality, others simply point out an indivertible logic of a system gone
wrong. Findings have however mostly been limited to the United States, so
there is a necessity to provide a compelling, overreaching theory that will be
able to explain why the political system tends to get captured by special
interests regardless of a specific country’s institutional strength.69
An insightful paper by Bonica, McCarty, Poole, and Rosenthal tackles the
issue of inequality and democracy, asking why democratic forces haven’t
lowered inequality. They stress five possible reasons as to why the US
political system failed to address the issue of rising income inequality. The
first is an ideological battle of ideas that lowered support for transfers,
taxation, and financial regulation. The second was immigration and low
turnout among the poor, in addition to administrative measures that made it
more difficult for the poor to vote. The third was that rising wealth of the
population made a larger fraction of them less supportive of social transfers
(e.g., difference between Social Security, Medicare, and Obamacare). Fourth
is that the wealthy have used their resources to influence legislative and
regulatory decisions via lobbying and campaign contributions, and the fifth is
that the political process has further been undermined and distorted by things
like gerrymandering, filibusters, and political polarization resulting in
gridlocks, all designed to maintain the status quo of American politics, which
clearly benefits the few at the (indirect) expense of the many.70 Bermeo
however elaborates that democratic mechanisms may even prevent the
formation of broad-based support for more redistribution. Democracy is not
about achieving economic but political equality, a desire for the state to offer
protection against violence and of property rights. Therefore, many voters do
not see inequality as an issue of high enough salience for it to be directly
tackled by their governments. In other words, democracies can survive with
high inequality.71
 Hacker and Pierson directly attribute the rise of inequality in the United
States to political causes, rather than globalization or the skills-based
technological change hypothesis. According to them the most important
change since the 1970s was the rise in organizational capacity of various
special interest groups representing the wealthy elites (big business
organizing to reduce regulation and taxes).72 The decisions on resource
redistribution were not being made by the voters as suggested by the Meltzer
and Richard median voter hypothesis, but rather by a myriad of special
interests, as suggested by Olson. The elites have blocked reforms that could
hurt them and have promoted beneficial tax and regulatory policies, tilting the
gains from globalization in their favor (and hence causing the huge increase
in top incomes which drove income inequality up). The status quo favored
the elites, so they lobbied to preserve it, as McChesney has shown
describing this relationship as “money for nothing.”73
While Hacker and Pierson assign the blame for rising inequality to both
political parties in the United States, Bartels finds that political partisanship
is the main culprit. He too claims that inequality is, for the most part, a
political phenomenon but links its rise to the policy choices made during the
terms of Republican presidents. He finds that real incomes of middle classes
have doubled during a Democratic president compared to a Republican one,
while incomes of the poor and working classes have increased tenfold under
Democratic presidents compared to Republican presidents, controlling for
all other factors. Bartels even goes so far to suggest that income inequality
would have stagnated during the past 60 years had there always been a
Democratic president in power, and that it would have been twice as high as
it currently is had the Republicans been in power for all this time. These
claims hardly constitute a causal link between Republican presidents and
inequality, as the statistical analysis is overly simplified, suffers from
endogeneity issues, and is based on a very small sample to be able to
adequately convince the reader in the validity of the argument. However,
there are clear policy differences between the two main US political parties
that arguably have made different impacts on inequality in the past several
decades (for example, in tax cuts, minimum wage legislation, labor union
power, etc.) His explanation is therefore that inequality was driven by
partisan policy decisions.74
He also finds evidence of politicians in power being more likely to
represent the preferences of the wealthy rather than the general population, a
conclusion that has further been examined and confirmed by Gilens. These
findings testify to a significant increase in political inequality in the United
States, suggesting the lack of representation of the poor and middle classes
whose preferences are almost always subverted to those of the rich. This too
could have contributed to the rise of income inequality as the wealthy
(roughly approximated and underrepresented by the top 10% income earners)
consistently get the policies they prefer (economic, social, religious, or
foreign), whereas policy preferences of the median income voters and those
in the lowest 90th income percentile are consistently ignored. The same
finding is confirmed for interest group policy preferences. The poor and the
middle classes don’t always lose—they get the policies they prefer only if
their preferences align with those of the wealthy or with a given interest
group (however interest groups tend to represent very narrow groups of
citizens in most cases, so the likelihood of their alignment with the general
population is low). Accordingly, US democracy became the service of the
wealthy and organized few instead of the disorganized many.75 Moss, through
a series of case studies and interviews with Washington insiders, delivers a
similar finding, suggesting that policymaking decisions in the United States
are not driven by what the voters want, but are a consequence of diligent
interactions between politicians and special interests who both achieve their
goals at the expense of the rest of society.76
Overall, such findings are striking. Not only do they imply that when it
comes to affecting policy change the elites and special interests fare most
successfully, they also indirectly imply that such groups could have an
important say in setting the agenda that, in most cases, preserves the status
quo. This means that the institution of majority rule in America is to a large
extent disturbed. Citizens do not get to influence policy. Their preferences
only get represented if they happen to align with those of the elites and
special interests. Such a democratic order, skewed in favor of elite power,
explains the status quo bias of American politics and why is it so hard to
implement policy change.
⋆⋆⋆
The problem with the contemporary political system is that it has morphed to
such an extent that it can allow those with power to bend the very institutions
that serve to hold it accountable. The political elites and special interests
tied with them managed to bend the rules to their liking, further skewing
budgetary resources, legislation, regulation, and hence the distribution of
income toward themselves. It is surprising to see this happening in a rich and
institutionally well-endowed country like the United States, particularly
since such outcomes were usually limited to either transitional economies of
Eastern Europe or Latin America, and to an even more grotesque extent to
developing countries in Africa and the Middle East. The capture of
governments by powerful elites is a pattern all too common throughout the
developing world, so one must ask why a similar pattern is apparently
occurring in the developed world. Why haven’t the institutional rules and
decades of accumulating democratic capital77 been able to prevent rent-
seeking and state capture? Why haven’t the forces of democracy embedded
by a strong constitutional and institutional order prevented the rise of
inequality? The same logic of power operates throughout developed
democracies and throughout political-economic systems. This is not an effect
caused by democracies, but rather by the quest for power. Even the strongly
embedded institutional safeguards in democracies cannot always stay robust
to the logic of elite network power, which is why we must look within such
networks to get a better understanding of how they operate.
These arguments get us closer in being able to attribute rising inequality to
elite networks, which distort the political process to serve their private
interests, but there is still one step missing—a coherent individual-level
empirical proof on how the mechanism works. More precisely, we need to
establish a mechanism on the level of individual politicians and individual
corporate executives through which their distortion of the political process
widens the gap between the top income earners and the rest. This is the topic
of the following chapter.
 4
Political Networks and Wages of Top Corporate In
come Earners

Too often, executive compensation in the US is ridiculously out of line with performance. That
won’t change, moreover, because the deck is stacked against investors when it comes to CEO
pay.
—Warren Buffet

Inequality, as emphasized in the previous chapters, is a product of many

different interrelated factors. This chapter focuses its attention on a factor
that has thus far mostly been overlooked in discussions on inequality—the
impact of political connections of corporate executives. I introduce a new
way of measuring elite networks while also directly estimating the wage
premium that executives receive if they are politically connected. Following
the definition from Chapter 1, an elite network is formed between politicians
in power (holding executive elected positions, cabinet positions, or key
positions in parliamentary committees) and senior executives of the biggest
publicly listed companies in a country. The network is formed based on
proximity to each other through a similar career path or membership in the
same organizations (clubs, societies, foundations, religious groups, etc.).
Within an elite network, favors are exchanged between actors. These usually
imply beneficial regulations or government contracts (rents) for the firm in
exchange for political campaign donations or other form of support for the
politician. The executive, who had successfully extracted rents for the firm,
can demand a higher compensation for his efforts.
An empirically observable consequence of this relationship is that
executives who are members of elite networks have higher average annual
earnings than executives who are not members of elite networks—they
receive a wage premium, which is a direct consequence of their political
connection. In order to approximate the effect of elite networks I use a unique
individual-level and firm-level database from BoardEx across a 16-year
time span for the United States and the United Kingdom, and identify which
individuals had connections to politics either via their previous careers in
the public sector (if they held any high-level positions in government) or if
they were members of the same organizations as their connected politicians
(this includes country clubs, foundations, charities, trusts, church or religious
groups, professional organizations, etc.). The theoretical implication of why
and how these networks form between individuals is the topic of Chapter 5.
This chapter delivers the cornerstone empirical argument of the book. It first
describes the data and looks at the trends of inequality over the stipulated
time period for both countries, after which it presents the results of the
empirical analysis.
The empirical conclusions suggest that politically connected executives,
i.e., members of elite networks, tend to be more valued by their companies
and are indeed rewarded with higher compensations. Furthermore, elite
network members tend to have a larger total number of people they are
connected to, meaning that any member of an elite network is highly likely to
be on average more (and hence better) connected than anyone outside an elite
network. Both of these factors matter as an explanation of higher executive
earnings, however direct political connections matter more. Being connected
clearly matters in the business world, and it tends to get substantially
rewarded.

4.1. Data and Variables

The main source of data are individual-level connections and earnings of top
corporate executives in the United States and the United Kingdom from 2000
to 2015, collected by the private company BoardEx, accessed via the
Wharton Research Data Service.1 The BoardEx database is assembled by
looking at all publicly listed companies of a given country in addition to
selected large private companies (not listed on the stock market but reaching
considerable size in terms of both employees and revenues). The quality of
the dataset is one of its main advantages. They use official sources to gather
information on individual profiles for each senior executive in their sample
of firms. When doing so they cross-reference whether the data has been
assigned correctly to each profile, and they make sure that each profile is
completed, subject to data availability in the official registries. In the United
States they use Annual reports from the Securities and Exchange Commission
(SEC), US stock exchange data (NYSE and NASDAQ), press releases and
official data from corporate websites, and various other registries to track
individual careers over time. For the United Kingdom they use official
reports from Companies House, the London Stock Exchange, the Regulatory
News Service, press releases and official reports from corporate websites,
and various other registries of personal data.
They have data on 11,800 firms in the United States and 3,500 firms in the
United Kingdom (some of which got de-listed over time), while the total
sample contains two-thirds publicly listed companies and one-third large
private companies. In total they have data on over 750,000 individuals
worldwide collected over a number of different periods. In each case they
collect full information for each director and senior manager in the firm
(director, CEO, CFO, COO, president, chairman, VP), including their wages
and total earnings (containing bonuses and stock options), employment
history, gender, age, education, total experience, performance, the size of
their network, and membership in other activities outside their workplace.
The size of the network represents the total number of people an individual
executive is connected to through various business and personal interactions.
For example, two executives that served on the same board in another
company before, graduated on the same year from the same university degree,
or are members of same organizations (business clubs, professional
organizations, nonprofit associations, church groups, charities, school or
university boards, etc.), are considered to be members of each other’s
networks. They might not be friends or interact frequently, but there is a
connection that can enable one of them to easily get in touch with the other.
From this extensive dataset I focused on the period from 2000 to 2015
(the year 2000 is when the dataset starts). I extracted individual-level data on
over 26,000 individuals working at 1,300 firms in the United States, in
addition to over 21,000 individuals working at 2,500 firms in the United
Kingdom.2 From the full dataset I created four panels, two individual-level
and two firm-level. The initial datasets had to be further reduced by focusing
only at senior top-level executives and the company’s highest earners
(president, chairman, director, CEO, CFO, COO) thereby excluding all
lower-level earners in the corporate hierarchy, many of which were included
in the original dataset. The final individual-level datasets contain 46,299
observations for the United States, and 31,422 observations for the United
Kingdom. The firm-level datasets contain 12,829 observations for the United
States (around 800 firms), and 19,908 observations for the United Kingdom
(around 1,200 firms).

4.1.1. Measuring Networks and Connections of Individuals and F

irms

4.1.1.1. Network Size

Measuring the size and scope of individual connections is the most valuable
part of the BoardEx database. It allows a detailed insight into how important
it is to be a part of a particular network. An individual executive’s network
is measured as the number of connections (links) he or she has with every
other executive in the dataset. The larger the number of an individual’s
connections (the degree of a network), the more influential he or she tends to
be. These connections are achieved either through previous jobs,
memberships on boards in other companies, education (same generation
and/or university major), or membership in various other organizations
(which include clubs, charities, church groups, university or school boards,
nonprofits, etc.). An individual’s network, or total number of connections,
therefore includes everyone he or she was or currently is connected to
throughout their career, education, or other activities.
Despite the effort the BoardEx team applies in making sure the data is
entered correctly, there is still a possibility of measurement error. In
particular, some individuals tend to have very large networks (over ten
thousand people), while others seem to be connected to only a few people.
An executive at a high position with such few connections is surely an
underestimation, however given that BoardEx links executives only within its
dataset it is entirely plausible for some to have such low levels of
connections (less than 10). On the other hand, individuals with over 10,000
connections are not necessarily superconnected. These are mostly lawyers
belonging to bar associations of their state, so the dataset lists them as
connected. Every person that wants to practice law in a state has to pass a
bar exam and therefore become a member of the state bar association, which
means that these individuals are highly unlikely to be connected to so many
people. The point is to look at individuals with several thousand connections
—these are more likely to be the central hubs of their networks, and discard
the lawyers with an unrealistically high number of connected individuals.
Consider a few examples. Jamie Dimon, the popular CEO of JP Morgan
whose network was drawn in Chapter 1 (Figure 1.7.), has 5,776 connections
in the database through various organizations he belongs to (most of which
through his job, but also through charity organizations, business groups, and
the New York Fed). Brian Moynihan, the CEO of Bank of America has 6,184
connections and belongs to a lot of similar organizations as Dimon. Lloyd
Blankfein (4,499 connections) and David Solomon (2,656 connections),
former and current CEOs of Goldman Sachs, both, for example, belong to the
Robin Hood Foundation, a charity that helps fight poverty in New York, and
are obviously connected to a lot of the same individuals through their jobs.
Outside of finance, the CEOs of Microsoft and Alphabet, Satya Nadella and
Sundar Pichai, have 5,699 and 4,167 connections respectively, more than
most other big business CEOs (Tim Cook of Apple has a network of 2,559
connections). Interestingly, the wealthiest individuals in the database, such as
Warren Buffet (1,465), Jeff Bezos (2,222), Elon Musk (1,054), or Mark
Zuckerberg (1,473) all have less connections than the average bank or
corporate CEO, which is expected—the CEOs need to network much more
than the most powerful business leaders or investors (George Soros, Bill
Ackman, and Ray Dalio are also averaging around 1,000 connections,
despite being investor superhubs). Those in between politics, academia, and
business also tend to have many connections. Larry Summers has 4,888, Ben
Bernanke 3,128 (pictured in Figure 1.6. in Chapter 1), while Peter Orszag
and Jack Lew top them all with 8,052 and 9,149 connections respectively
(although Lew’s are slightly overestimated due to him also being a member
of the DC Bar association).
Network size is therefore the first explanatory variable, attempting to
estimate how the mere size of an executive’s total personal and business
connections influences his or her earnings. The hypothesis is that the larger
the size of an individual executive’s network, the greater his or her earnings,
resting on the assumption that a well-connected executive has a greater
chance of securing a better deal for the firm.

4.1.1.2. Political Connections

Another unique advantage of the BoardEx database is the ability to examine
career trajectories of executives and board members prior to their top
positions in the firm, as well as their memberships in various organizations.
These two facts enable me to match individuals to their previous positions in
government and to each other in order to define the main variable of interest:
political connections, defined as an indicator variable . The
main variable is composed of two specific measures of connections:
previous government experience, denoted , and membership in the
same organization as the relevant politician,3 denoted . I first
explain how I coded each of these to form my unique measure of political
connections, and then I describe the dataset matching process through which I
ensure that each individual is uniquely and correctly matched.
The first subvariable, , defines an individual to be politically
connected if that individual held a decision-making position in government at
any time prior to the start of his current executive tenure in the private sector.
Establishing this connection required additional cleaning of the database,
which implied cross-checking which type of position a senior executive held
while working in the public sector. If this included medium or low-level
bureaucratic positions (e.g., analyst, officer, civil servant, assistant,
researcher, clerk, etc.) these individuals were coded as not being connected,
. However, if they were members of various state and national
committees, councils, or assemblies, not to mention if they held direct
executive positions in government (manager, director, chief of staff,
chairman, minister, congressman, senator), this does qualify as a political
connection, . This variable encapsulates the idea that after
leaving their position in government, a senior executive continues their
membership in the social network of existing political decision-makers.
The second subvariable, , looks at whether an executive was
connected to a politician via membership in the same organization. What
classifies as an organization? The BoardEx Data Directory defines these
through “other activities” and provides a detailed list of all organizations
every executive is or was an active member of. The list is large, and it
includes a wide variety of organizations: professional organizations
(excluding bar associations in this case, but including any type of industry
lobby group), clubs (country clubs, Rotary clubs, various societies),
university of school boards (and their alumni organizations), NGOs,
institutes and think tanks, trusts, foundations, charities, church groups and
various other religious organizations, veteran or military organizations,
various political advocacy groups, and even political parties.4
Coding these two subvariables required a lot of attention to detail.
Establishing government experience was relatively straightforward: it
required matching two separate datasets, one that tracked previous executive
careers (manually excluding all lower-level bureaucratic positions first), and
the main dataset that contained data on executive earnings and firm-level
details. However, coding was more difficult. The first step was to
recognize which entry in the sample is still a career politician (this included
congressmen, senators, members of parliament, assembly legislators, mayors,
governors, cabinet ministers). Then I divided the samples into (active)
politicians and nonpoliticians (just executives) and matched the two samples
by the organization ID. This enabled me to see which executives and
politicians are members of the same group, and to how many politicians in
total an individual executive is connected. I’ve excluded all cases where the
timing between the links does not fit to make sure that I correctly coded the
connections.
This means that any national or local-level politician (from cabinet
ministers to mayors, including the legislators like members of Congress or
Parliament) had to be a member of the same organization as the corporate
executive in order for the executive to be coded as politically connected.
This relationship is taken as prima facie evidence of a connection within an
elite network. Given that BoardEx also has data on political figures and their
affiliations it was straightforward to pick out which individuals belonged to
the same organizations.
The final variable was then created by simply adding the two
subvariables together, with the indicator taking the value of 1 if an individual
worked at a decision-making position in the government at any time prior to
his or her executive job, and/or if he is a member of the same organization as
the local or national legislator (assemblymen, congressmen, and senators) or
executive politician (mayor, governor, secretary of state, or cabinet minister).
In total for the United States there were 4,561 cases (9.8%) of previous
government experience (across 16 years), and 30,921 cases (66.7%) of same
organization membership, however there were about 3,000 cases where an
individual had both previous government experience and was member of the
same organization as the politician. These were also coded as 1. In total for
the United States, across 16 years, there were 32,412 entries coded as
politically connected (70% of the sample). In the United Kingdom, there
were 2,490 entries (7.9%) with previous government experience, and 12,063
cases (38%) of same organization membership. In total there were 12,850
entries coded as politically connected (40.1% of the sample) across 16
years. This may seem like a lot, particularly in the United States, but
apparently executives from both countries realize the importance of being
connected to politics. These connections need not however imply direct
friendships. They just suggest that it is easier to reach a politician if he or she
is a member of your organization.

4.1.1.3. Firm-Level Political Connections

When aggregated on a firm level, I use two versions of the POLCON
classification, each constructed by summing up individual executives by
unique firm ID for each firm in the dataset. The first indicator of connections
is constructed if a firm had at least one senior executive that was politically
connected, denoted as (POLCON Firm in the results section).
However, for this first case I had to be more restrictive and focus only on
previous government experience. In other words, I use only the
variable to construct POLCON Firm. If I take into account same organization
membership there would be virtually no variation in the US case, as almost
every firm had at least one person that was politically connected via same
organization membership. In this case, when looking only at executives with
previous government experience, about 60% of US firms can be coded as
politically connected. This allows enough variation to get comparable
estimates as with the individual-level data. In the United Kingdom I get about
40% of firms that had a politically connected executive with previous
government experience.
 For this reason, I also construct the second POLCON variable for firms,
where I look at the total number of all politically connected senior executives
in a firm, denoted as . The idea is to distinguish between firms with
low and high numbers of connected executives in their boards. In reality all it
takes is a single well-connected executive to land an exclusive contract with
the government. However, firms where the entire board is filled with
connected executives are clearly better examples of corporate rent-seekers
than those with only a single connected executive. Theoretically they should
both be considered as politically connected, but this way I get a better
distribution of connected individuals within them, and hence a more precise
estimate of the marginal effect of political connections—the value of an
additional connected board member. There is a clear difference between US
and UK firms. In the United States the distribution is wider (there are firms
with up to 15 connected executives) and the majority of firms have between 1
and 5 connected executives. In the United Kingdom the distribution is
narrower, and politically connected firms have in most cases between 1 and
2 connected executives.

4.1.2. Correlation between Political Connections and Network Siz

e
How do political connections correlate with network size? The first
interesting descriptive finding is that a person who is politically connected
has on average a much larger network. Table 4.1 shows t-tests for network
size according to the indicator of political connections for the two countries.5
In both cases the network of politically connected executives is two to three
times the size of politically unconnected executives.6 The firm-level data for
both countries indicates exactly the same conclusion—executives in
politically connected firms have significantly larger networks than executives
in nonconnected firms. This adequately sums up the main explanatory
variables—being part of elite networks also implies being better connected,
and most likely more influential. This could imply that elite networks have a
tendency to be topocratic,7 where it matters who you know in the decision-
making hierarchy.
Table 4.1 Descriptive statistics and t-tests for individual network size with respect to political
connections
Mean St.Dev. Min Max N
United States network size
Politically connected = 1 1539.7 1574.8 13 16338 31803
Politically connected = 0 673.7 814.1 10 6185 13621
United Kingdom network size
Politically connected = 1 1473.2 1539.8 7 9792 12692
Politically connected = 0 399.6 701.1 4 7967 18300
T-test connected vs. unconnected T-test connected vs. unconnected
(US network size) (UK network size)
866.1*** 1073.6***
(60.8) (82.7)

4.2. Inequality in Top Executive Incomes

Another useful part of the BoardEx database is extensive data on annual
individual earnings, including data on salaries, bonuses, stock options,
pension contributions, and total direct compensation for each executive. Two
outcome variables are created from this data: the logarithm of salary (log
salary) for each individual, and the logarithm of total direct compensation
(log earnings) as a measure of total annual pretax earnings for each
executive, which includes salary, bonuses received (if any), capital gains (if
any), and pension contributions. The focus on top executive earnings is
contingent on the fact that top incomes (of 0.1% of income earners) are the
key driver of income inequalities over the past 40 years, while over 60% of
those in the top 0.1% are typically corporate executives. The presumption is
therefore that the majority of the increase in top incomes, and hence income
inequality, can be explained by the increase of top executive incomes (as was
made clear in the previous two chapters).
The first useful thing would be to plot this data to see if executive
earnings as reported in the database followed the same trends of reported
increases in top incomes over the past years. Figures 4.1 and 4.2 show the
distribution of individual executive earnings for both countries, and they
suggest a similar finding to the majority of income inequality literature: even
among top earners, the top 1% of executives have much higher total earnings
than the rest. In these examples, the top 1% of highest-paid executives in the
United States had higher total annual earnings than 99% of all other
executives combined (keep in mind that the minimum total compensation in
the sample was $150,000) (Figure 4.1, lower panel). For salaries the
distribution is flatter, but it still suggests that the top 5% of highest-paid
executives in the United States had higher total annual earnings than 95% of
all other executives combined (Figure 4.1, upper panel). For the United
Kingdom the distributions are almost identical, with the difference being that
in the United Kingdom the top 1% of executives had slightly higher relative
salaries than in the United States, but slightly lower relative total earnings.
Once again, the top 1% of executives have higher total annual earnings than
the other 99% of executives combined (Figure 4.2, lower panel), while 5%
of executives have higher annual salaries than the other 95% combined (Figu
re 4.2, upper panel).
Figure 4.1 Percentile histogram for individual salaries (upper panel) and individual total earnings (lower
panel), United States.
Figure 4.2 Percentile histogram for individual salaries (upper panel) and individual total earnings (lower
panel), United Kingdom.

Next, we look at the trends for log earnings over the observed 16-year
period. Overall, they suggest that executive incomes have continued their rise
over the observed decade and a half, and that even after a correction in the
trend during the crisis and precrisis years the general trajectory hasn’t
changed. In the United States there is a noticeable difference in trends for
salaries (Figure 4.3, upper panel), which carry an almost uninterrupted
upward trajectory during the entire period, and total earnings (Figure 4.3,
lower panel) which underwent a large decline that started two years before
the crisis, only to recover after 2009 but growing somewhat slower than
before the crisis. The trends for the United Kingdom are slightly different;
both salaries and total earnings peaked just before the crisis in 2007,
experienced a correction which lasted for two years, and then, ever since
2010, continued to grow at almost the same pace as before the crisis (Figure
4.4). By 2015 both salaries and total earnings in the United Kingdom were
higher than their precrisis peak. For the United States this was only the case
for executive salaries, as total earnings still haven’t bounced back to their
precrisis levels.
Figure 4.3 Annual changes in individual executive salaries (upper panel) and total earnings (lower
panel), United States, 2000–2015. Logarithmic values of salaries and earnings are used.
Figure 4.4 Annual changes in individual executive salaries (upper panel) and total earnings (lower
panel), United Kingdom, 2000–2015. Logarithmic values of salaries and earnings are used.

Looking at the trends of top incomes on a firm level, similar conclusions can
be inferred for the United States: a steady rise of executive salaries (Figure
4.5, upper panel), and a similar correction of executive total earnings (Figure
4.5, lower panel) followed however by a stronger rebound after the crisis,
reaching its precrisis peak in 2015. In the United Kingdom the firm-level
data paints an entirely different picture (Figure 4.6). It suggests that both
salaries and total earnings of executives have, at least on a firm level, been
declining since 2000. However, since 2009 the trend has picked up and is
moving upward again. The firm-level data in the United Kingdom suggests
that average firm-level inequality has been gradually declining until after the
crisis, in spite the fact that individual executive top incomes have been
steadily rising in the same period. This fact is in alignment with the UK Gini
coefficient and the UK top income share data,8 which suggest stagnating
income inequality during the observed 16-year period.
Figure 4.5 Annual changes in firm-level executive salaries (upper panel) and total earnings (lower
panel), United States, 2000–2015. Logarithmic values of salaries and earnings are used.
Figure 4.6 Annual changes in firm-level executive salaries (upper panel) and total earnings (lower
panel), United Kingdom, 2000–2015. Logarithmic values of salaries and earnings are used.

Given that the focus of this book is to examine the impact of political
connections on inequality, it would be useful to observe the same trends of
increasing executive incomes with respect to individual and firm political
connections, as defined in the previous section. Figures 4.7 and 4.8
decompose individual-level executive earnings by political connections (the
main variable POLCON) for both countries, while Figures 4.9 and 4.10
decompose firm-level executive earnings by political connections (again
POLCON) for both countries. In all four cases the conclusion is identical:
politically connected individuals and firms (red lines, denoted as 1) have
had higher salaries and total earnings than unconnected individuals and firms
(blue lines, denoted 0) during the entire observed period. In some cases,
even the growth of earnings for connected executives was higher. For
example, the trend of total executive earnings in the United States (Figure
4.7, lower panel) clearly shows that the growth of earnings for connected
executives was faster than for nonconnected executives pre-2005 but also
since 2013. However according to only this evidence it is inconclusive
whether political connections actually caused the increase in top incomes. It
seems instead that the difference in top earnings by levels of political
connections is a time-invariant characteristic of US and UK labor markets.
Figure 4.7 Annual changes in individual executive salaries (upper panel) and total earnings (lower
panel), decomposed by political connections, United States, 2000–2015. Logarithmic values of salaries
and earnings are used.
Figure 4.8 Annual changes in individual executive salaries (upper panel) and total earnings (lower
panel), decomposed by political connections, United Kingdom, 2000–2015. Logarithmic values of
salaries and earnings are used.
Figure 4.9 Annual changes in firm-level executive salaries (upper panel) and total earnings (lower
panel), decomposed by political connections, United States, 2000–2015. Logarithmic values of salaries
and earnings are used.
Figure 4.10 Annual changes in firm-level executive salaries (upper panel) and total earnings (lower
panel), decomposed by political connections, United Kingdom, 2000–2015. Logarithmic values of
salaries and earnings are used.

Other variations of this relationship with the POLCON variable unpacked by

origin of connections (previous political experience, or
membership in the same organization ) all confirm the same story:
no matter how we define political connections, being connected implies a
higher level of executive salaries and total earnings.9 These results are
presented in greater detail in Tables 4.3 and 4.7 and they suggest that in the
United States membership in the same organization is a more important
driver of the earnings difference between connected and unconnected
executives, while in the United Kingdom previous government experience
drives a bigger wedge between connected and unconnected executive
earnings.

4.3. Empirical Strategy and Results

It is difficult to impose a causal relationship between political connections,
network size, and executive earnings. First of all, a decision of a firm or
individual to become connected and join an elite network is highly
endogenous, meaning that connected individuals and firms self-select into the
treatment group. Second, some firms are simply large in size and employ a
lot of people in their local communities, which makes them more likely to
capture the attention of politicians, regardless of whether they really benefit
from any connections. And third, there could be a number of factors that
affect both individual executive earnings and someone’s incentive to join an
elite network. For example, individual ability or competence (or even
likability) makes someone more likely to earn a higher salary and at the same
time more likely to engage with a larger network of other individuals. For
firms, the decision on earnings and connections can be related to their
relative stage in the life cycle. Firms in the later stages of the life cycle are
less responsive to disruptive technologies, which forces them to turn to
political support and capturing rents in order to survive. In this case the
position in the phase of the life cycle will determine the assignment of firms
into connected and nonconnected and will simultaneously also affect the
earnings they pay to their executives.
Using fixed effects on a panel dataset for a period of 16 years helps
resolve some of these difficulties. Fixed effects are useful in controlling for
any time-invariant factors that cannot be observed (such as executive ability)
or are difficult to measure precisely (firms that capture political attention;
stage of the firm life cycle) but can be a source of endogeneity and between-
unit differences. When observing the effect of changes in political
connections or network size on the changes in earnings over time all such
time-invariant differences get canceled out allowing us to estimate a clear
within effect. In this particular case I use firm-level fixed effects to estimate
the effect of being politically connected vs. being politically unconnected
within firms over time. I therefore answer the question of whether it pays off
for an executive within a firm to be politically connected.
The logic behind including time fixed effects is similar—time fixed
effects tend to capture all time-varying variables and trends that affect
outcomes for all units in the same way. For example, in the figures above it
was obvious that earnings growth was interrupted during the financial crisis.
Including time fixed effects controls for this as the crisis was an event that
had an impact on all units in the same way. The following regression is
estimated for individual-level data for both countries.

(4.1)

The outcome variable indicates either log salary or log total earnings
for individual in year . The two main explanatory variables denote the
indicator of political connections for an individual, , and the size of
his or her network, or the degree of the network, , where represents the
total network. These two estimates represent the wage premium as suggested
by equation 4.1. is the firm fixed effect and is the year fixed effect.
Finally, represents a set of covariates that include education level, age,
gender, total experience (time in current firm plus time in other firms), total
number of boards the person sits on, bonus ratio (size of bonus relative to
total earnings), and equity ratio (size of equity-based compensation relative
to total earnings).
 The same equation is estimated for firm-level data for both countries,
using the same indicators and covariates but aggregated on a firm ( ) rather
than an individual level. The only difference is that two versions of the
variable are used, an indicator version , and a continuous
version .

(4.2)

The validity of the fixed effects approach rests on the assumption that any
unobservable factors related to the treatment are indeed fixed over time. The
estimation tends to control for a number of factors that could affect executive
earnings on both an individual and firm level, plus it tends to cancel out
unobservable factors that remains fixed over time, but it can still be
vulnerable to any unobservable factor that does vary across time and is not
controlled out by the time fixed effect.10
In order to at least partially address these concerns on the firm level I use
industry-level averages of political connections as firm-level instruments, a
strategy suggested by Angrist and Krueger to resolve measurement error
issues,11 and applied by others to control for firm-level unobservables.12
This strategy suggests taking average levels of connections (when defined as
a continuous variable, ) across each industry and use it as an
instrumental variable (IV) for firm-level connections within that industry.
The assumption is that any variation across industries is not likely to be
driven by unobserved firm-specific factors, but rather by industry-level
characteristics that are likely to be exogenous to firm-level choices over its
wage structure. In other words, all firm-level unobservables that are likely to
be correlated with its executives’ earnings (and that vary over time) are not
affecting the outcome if we use industry-level connections. Given that the IV
is an industry-level variable the variation only remains on an industry-level,
rather than firm-level. Simultaneously, this is the biggest disadvantage of the
proposed IV approach.
The first stage is satisfied given that firm-level connections are correlated
to industry-level connections, as any firm-level influence will depend on its
industry-specifics (such as the regulatory status of that industry, its strategic
importance to politics, sensitivity to foreign shocks, etc.). The 2SLS
estimation procedure is used, where equation 4.3 estimates the first stage
relationship while equation 4.4 estimates the second stage relationship:

(4.3)

(4.4)

Where is the industry-level average of political connections for each

firm in year . All the other variables are the same as in equation 4.2.

4.3.1. Results: United States

Table 4.2 shows the results for the effect of political connections and
network size on individual-level executive earnings in the United States. The
first two columns show results for log values of the outcome variables: log
total earnings and log salary, while the final two columns show results for
absolute levels of executive total earnings and salaries so as to get a better
idea of the monetary value of the effect.
Table 4.2 Individual level executive earnings and political connections, United States. Covariates
include the following: education, experience, membership on other boards, bonus ratio, equity ratio,
gender, age. T-value shown in parentheses. *** denotes significance at 0.1%
(1) (2) (3) (4)
Log total earnings Log salary Total earnings Salary
POLCON 0.119*** 0.121*** 153.9*** 73.16***
(23.8) (31.02) (9.62) (20.9)
Network size 0.017*** 0.016*** 30.51*** 11.36***
(16.9) (16.0) (6.07) (10.34)
Covariates YES YES YES YES
Firm fixed effects YES YES YES YES
Time fixed effects YES YES YES YES
Observations 44071 44071 44071 44071
R squared 0.653 0.577 0.455 0.506

The results show a strong positive effect of both political connections and
network size on individual executive total earnings and salaries. The
interpretation of the main effect is focused on the difference between
individuals within firms. It helps us answer the question: does it pay off for
an executive within a firm to be politically connected? Being a politically
connected executive results in 12.6% total higher individual earnings,13 and
about 12.8% higher salaries than nonconnected executives. For an average
executive compensation of around $1.18 million per year, this corresponds to
an annual pay rise of about $150,000. The absolute value of the effect
(estimated in columns 3 and 4) is similar. A switch from a nonconnected to a
connected individual within a firm increases total earnings by almost
$154,000, while it increases salaries by $73,160. The substantial size of the
estimated effect in each case suggests that it certainly does pays off to be
politically connected within publicly listed firms in the United States.
The network size effect also has to be taken into account, even though it is
more modest. The variable network size was divided by 1,000 for easier
interpretation of the coefficients. The results from Table 4.2 suggest that for
every increase in an individual’s network size by 1,000 people (which is
two-thirds of the standard deviation increase of 1,435), salaries and total
compensation go up by around 1.7%. In absolute terms this corresponds to
$30,500 higher total compensations and $11,360 higher salaries. Given that it
isn’t likely for executives to expand their networks by 1,000 people each
year, the network size effect is even more modest. It is however suggestive
that better connected individuals do carry a greater weight in firms’ reward
structures. It just happens that political connections carry an even greater
one. The main driver of the rent-seeking premium are therefore direct
political connections. The size of this premium for individual executives is
about $70,000 in salaries, and about $150,000 in total earnings.
The results reported in Table 4.2 only look at the total value of the
POLCON variable. Table 4.3 unpacks the POLCON by the origin of an
executive’s connection—is it due to his or her previous experience in
government, or is it due to membership in the same organization as the
relevant politician? All three cases are reported, where columns (1) and (4)
merely repeat the same findings as columns (1) and (2) in Table 4.2. In the
US case it is clear that the same organization membership effect is stronger
than the previous experience in government effect. In particular, a political
connection of an executive resulting from previous government experience
increases total compensation by 6.2% and salaries by 5.6%. On the other
hand, a political connection of an executive resulting from membership in the
same organization as a politician increases total compensation by 10.1% and
total salaries by 10.6%, which is closer to the overall POLCON effect.
Clearly both of these forms of connections increase executive earnings,
however, at least in the US case, being a member of the same social group as
a politician is more important (and more rewarding) than being connected to
them through previous jobs.
The same disentangled effect is estimated in absolute terms (not shown
here), and even though it implies the same conclusion for salaries—$60,000
higher salary for the organization effect and $40,000 for the experience effect
—it suggests the opposite for total compensation. Total earnings increase by
$165,000 for an executive with previous government experience, and by only
half as much for an executive who is a member of the same organization as a
politician. The network effect in each case is similar to the one estimated in
Table 4.2.

Table 4.3 Individual level executive earnings and political connections by origin of connection, United
States. Covariates same as in Table 4.2. T-value shown in parentheses. *** denotes significance at
0.1%
(1) (2) (3) (4) (5) (6)
Log total Log total Log total Log Log Log
earnings earnings earnings salary salary salary
POLCON 0.119*** 0.121***
(23.8) (30.25)
POLCON_Gov 0.059*** 0.054***
(9.83) (10.8)
POLCON_Org 0.096*** 0.101***
(23.9) (33.67)
Network size 0.017*** 0.023*** 0.019*** 0.016*** 0.022*** 0.018***
(16.9) (22.9) (19.1) (16.1) (21.8) (17.6)
Covariates YES YES YES YES YES YES
Firm fixed YES YES YES YES YES YES
effects
Time fixed YES YES YES YES YES YES
effects
Observations 44071 44071 44071 44071 44071 44071
R squared 0.653 0.648 0.651 0.577 0.569 0.575

Table 4.4 presents the estimates of the same relationship but on a firm
level, where all the main variables and covariates are aggregated from the
individual-level dataset. The table does not show results for absolute level
earnings any more, but instead shows versions with and without time fixed
effects. Many versions were estimated using different combinations of the
covariates and interaction terms, and different versions of the outcome
variables, but the results remain robust in each case. They yield an almost
identical conclusion to the individual-level estimates: political connections
on a firm level carry a strong, significant, and positive effect on top
executive earnings.

Table 4.4 Firm-level executive earnings and political connections, United States. Same covariates as in
Table 4.2 but on a firm level. T-value shown in parentheses. *** denotes significance at 0.1%
(1) (2) (3) (4)
Log total earnings Log total earnings Log salary Log salary
POLCON Firm 0.027*** 0.025*** 0.019*** 0.018**
(3.87) (3.68) (3.55) (3.42)
Firm network size 0.027*** 0.023*** 0.022*** 0.018***
(15.97) (13.74) (16.82) (14.47)
Covariates YES YES YES YES
Firm fixed effects YES YES YES YES
Time fixed effects NO YES NO YES
Observations 12810 12810 12809 12809
R squared 0.462 0.509 0.351 0.421

The only difference is that the effect is more modest on a firm level,
which is expected. Top earnings across all executives in the board should
even out and produce a smaller effect than when looking only at individuals.
A politically connected firm compared to a politically unconnected firm pays
its executives between 2.5% and 2.7% more in total earnings, and between
1.8% and 2% more in salaries. Although this seems modest in absolute terms
it translates to about $30,000 higher annual earnings paid to executives in
connected firms. The network effect is similar as before, between 2.3% and
2.7% higher total earnings, and around 2% higher salaries for every increase
in network size by 1,000 people.
Finally, the IV estimates on a firm level support the earlier conclusions.
They also indicate that firm-level political connections and network size
exhibit a large and positive effect on top executive earnings in the United
States. In Table 4.5 the first two columns report the effect of using political
connections as a continuous variable, counting the total number of politically
connected board members for each firm. The final two columns use the
indicator value of firm connections, as before.
The IV estimates, correcting for potential measurement errors by using
industry-level connections as an IV, produce much higher effects than
reported in Tables 4.2 and 4.4.14 According to the first two columns, the
more politically connected directors a firm had, the greater their earnings. In
particular by adding only a single director that is politically connected to a
firm’s board (which is a bit smaller than a one standard deviation increase of
1.5) yields a 16.5% higher salary and 22% higher total executive earnings
for that firm. The indicator value estimates of political connections of a firm
are even larger. They suggest that by switching from an unconnected to a
connected firm (by hiring a director with political connections), total
executive earnings in that firm will go up by 132%, while salaries will go up
by 87%. In both cases this is an enormous effect, much larger than the very
modest ones reported in Table 4.4. The network size effect remains roughly
the same however, between 1.6% and 2.5% for salaries and earnings. As
with the case of individuals, direct political connections seem to be the
biggest contributor to the wage premium.
Table 4.5 IV estimates of firm-level executive earnings and political connections, United States. Same
covariates as in Table 4.2 but on a firm level. T-value shown in parentheses. *** denotes significance at
0.1%
(1) (2) (3) (4)
Log total earnings Log salary Log total earnings Log salary
POLCON Total 0.221*** 0.165***
(14.02) (12.54)
POLCON Firm 0.842*** 0.628***
(13.67) (12.18)
Firm network size 0.018*** 0.016*** 0.025*** 0.021***
(13.77) (14.59) (25.46) (25.63)
First stage 2.655*** 2.654*** 0.696*** 0.696***
(30.72) (30.7) (25.7) (25.67)
Covariates YES YES YES YES
Observations 12810 12809 12810 12809
R squared 0.415 0.35 0.362 0.296

4.3.2. Results: United Kingdom

For the United Kingdom we once again start with individual-level results
shown in Table 4.6. As before, the first two columns show results for log
values of total earnings and salaries, while the final two columns show
results for absolute values of the outcome variables.
Similar to the US individual-level results, the UK estimates also suggest a
strong positive effect of political connections on individual executive
earnings. The effects, however, are smaller than in the United States. A
politically connected executive in the United Kingdom gets a 4.7% higher
total compensation and a 5.5% higher salary than a nonconnected executive
within the same firm. In the UK sample the average executive total
compensation was £965,000, meaning that being politically connected can
result in a raise of almost £50,000 annually. The absolute numbers suggest an
even larger effect, around £90,000 more in total earnings, and almost
£70,000 in salaries.

Table 4.6 Individual-level executive earnings and political connections, United Kingdom. Covariates
include the following: education, experience, membership on other boards, bonus ratio, equity ratio,
gender, age. T-value shown in parentheses. *** denotes significance at 0.1%
(1) (2) (3) (4)
Log total earnings Log salary Total earnings Salary
POLCON 0.046*** 0.054*** 89.39** 69.48*
(7.66) (10.8) (2.59) (2.34)
Network size −0.003 −0.002 2.827 −10.45
(−1.3) (−0.9) (0.212) (−0.91)
Covariates YES YES YES YES
Firm fixed effects YES YES YES YES
Time fixed effects YES YES YES YES
Observations 27236 27236 27236 27236
R squared 0.646 0.55 0.155 0.124

What is surprising in the United Kingdom is that the network effect for
individuals vanishes once political connections are involved, and even
points to an opposite direction (implying that having a larger network hurts
an executive’s earnings), however in neither case is it statistically
significant. This surprising result needs to be examined more closely by
again unpacking the origin of an executive’s political connections. Is it due to
one’s strong social network built in clubs, societies, and NGOs, or is it due
to one’s previous government experience, where all the important political
connections were initially established? Table 4.7 seems to suggest that the
latter is the case in the United Kingdom, exactly the opposite to the United
States. Previous government experience in the United Kingdom yields a
stronger effect than the overall POLCON estimate—it increases total
compensation by 7.5% and salaries by 8.25% (about £75,000 on average).
The organization membership effect is smaller than the overall POLCON
estimate—it increases total compensation by 3.4% and salaries by 4.2%
(about £38,000 on average). When looking at the disentangled effect in
absolute terms it makes an even stronger case. The previous government
experience effect increases total executive earnings by £230,000 annually,
and salaries by £135,000 annually. The organization membership effect in
absolute terms is not even statistically significant. The wage premium in the
United Kingdom is therefore fully explained by political connections derived
from previous government experience.
These findings could help explain the insignificance of the network effect
in the United Kingdom. Clearly the predominant way political connections
are formed in the United Kingdom is through direct government experience.
The clubs, societies, and various organizations may attract a large
membership but these are most likely clustered around the same type of
people. In other words, it is less likely in the United Kingdom that a club of
corporate executives invites an executive politician or legislator to be a
member, than it is in the United States.
Table 4.7 Individual-level executive earnings and political connections by origin of connection, United
Kingdom. Covariates same as in Table 4.6. T-value shown in parentheses. *** denotes significance at
0.1%
(1) (2) (3) (4) (5) (6)
Log total Log total Log total Log Log Log
earnings earnings earnings salary salary salary
POLCON 0.046*** 0.054***
(7.67) (10.8)
POLCON_Gov 0.072*** 0.079***
(7.98) (9.87)
POLCON_Org 0.034*** 0.041***
(5.67) (8.2)
Network size −0.003 0.002 −0.001 −0.002 0.004* -0.0003
(−1.3) (0.98) (−0.5) (−1.0) (1.98) (−0.15)
Covariates YES YES YES YES YES YES
Firm fixed YES YES YES YES YES YES
effects
Time fixed YES YES YES YES YES YES
effects
Observations 27236 27236 27236 27236 27236 27236
R squared 0.646 0.646 0.646 0.55 0.55 0.549

Jointly these results confirm the intuition from the US case that political
connections are important determinants of executive earnings, and that
political connections matter far more than the pure size of one’s network. In
the United States, political connections formed through memberships in same
organizations are the key drivers of higher earnings for executives, while in
the United Kingdom previous government experience is more likely to
increase an executive’s earnings.
Table 4.8 Firm-level executive earnings and political connections, United Kingdom. Same covariates as
in Table 4.6 but on a firm level. T-value shown in parentheses. *** denotes significance at 0.1%
(1) (2) (3) (4)
Log total earnings Log total earnings Log salary Log salary
POLCON Firm 0.0982*** 0.0994*** 0.0981*** 0.0988***
(8.46) (8.61) (8.7) (8.76)
Firm network size 0.056*** 0.055*** 0.052*** 0.051***
(17.04) (16.32) (16.31) (15.76)
Covariates YES YES YES YES
Firm fixed effects YES YES YES YES
Time fixed effects NO YES NO YES
Observations 19835 19835 19835 19835
R squared 0.234 0.236 0.116 0.116

Table 4.8 presents the same relationship on a firm-level. As in the US

case it does not report absolute earnings any more, but only different
estimates with and without time fixed effects. All possible calculations and
combinations produced similar effects yielding the same conclusion as in the
US case and in line with the UK individual-level findings: political
connections within a firm yield a positive and significant effect on top
executive earnings. What is interesting is that in all four cases reported here
(with and without time fixed effects for salaries and total earnings) the effect
is the same: around 10%. This is significantly higher than the modest firm-
level estimates in the United States, but in line with the results for individual
level estimates in the United Kingdom. Switching from a politically
unconnected to a politically connected firm increases both total earnings and
salaries of firm executives by an average 10%. In absolute terms this
translates to almost £100,000 higher executive annual earnings.
The network effect is now statistically significant and points to the right
direction, however its effect is still modest compared to the political
connection effect. Across all four estimates it stands around 5%, meaning that
a 1,000-person increase in network size increases executives’ salaries and
earnings around 5% annually on average. This may seem like a fairly decent
effect size, however we must keep in mind that not many executives can
expand their network by a 1,000 people each year. This implies that the
overall effect of adding individuals to one’s network is almost negligible.
Connections matter more on a firm level than an individual level in the
United Kingdom, although the total size of the network effect is still not as
impactful as the effect of political connections.
 The IV estimates for UK firms are more modest than the corresponding
estimates in the US case, although they also confirm all the earlier made
conclusions. Results are presented in Table 4.9, where the first two columns
report the effect when using political connections as a continuous variable,
counting the total number of politically connected board members for each
firm, while the final two columns use the indicator value of firm connections.
Even though they are smaller than the corresponding US IV estimates, they
do support the UK firm-level findings from Table 4.8. According to the first
two columns, adding one politically connected director increases salaries by
16% and total earnings by 12.5%. The estimates using the indicator value of
political connections are higher, however much more in line with all the
earlier presented results. Switching from a nonconnected to a connected firm
increases total executive earnings in a firm by 28%, and executive salaries
by an average 39%. This is a large effect indeed, but nowhere near the US
levels of 87% and 132%.
What explains such results overall? Executives who join firms coming
from high-level government positions and who are members of elite
networks tend to be more valued and hence better compensated by their
firms. One of the obvious reasons for this, as shown already in Table 4.1, is
that politically connected individuals have larger personal networks. In the
business world where networking is an extremely important feature of
securing new jobs and helping the company succeed, this is a valuable asset
that tends to be rewarded. However, the network effect is much more modest
than the political connections effect, and for the United Kingdom it is not
even statistically significant. It seems that in the United Kingdom social
networks matter less than direct links to the government. They still do matter,
particularly on a firm level, but their impact in the United States is much
stronger and hence more important.
Table 4.9 IV estimates of firm-level executive earnings and political connections, United Kingdom.
Same covariates as in Table 4.6 but on a firm level. T-value shown in parentheses. *** denotes
significance at 0.1%
(1) (2) (3) (4)
Log total earnings Log salary Log total earnings Log salary
POLCON Total 0.125** 0.164***
(3.26) (4.52)
POLCON Firm 0.250*** 0.329***
(3.3) (4.58)
Firm network size 0.097*** 0.084*** 0.11*** 0.089***
(27.08) (24.99) (40.11) (38.13)
First stage 1.328*** 1.328*** 0.6638*** 0.6638***
(29.2) (29.2) (24.35) (24.35)
Covariates YES YES YES YES
Observations 19835 19835 19835 19835
R squared 0.523 0.418 0.523 0.417

4.4. The Impact of Political Connections on Executive Salarie

s in Other Countries
The findings for the United States and the United Kingdom are striking.
Unfortunately, there is not enough data to fully validate the hypothesis in
other countries. Ideally, for each country of interest we would need to have
the same database of top executives and politicians which includes their
educational background, organization membership, and previous employment
to draw links between them. This way we could make inferences on whether
political connections are a stronger determinant of top corporate salaries in
high-inequality countries compared to lower-inequality countries.
Although this type of validation is, at the moment, unfeasible, a similar
pattern of political connections being an important determinant of top
executive earnings can be found in several other countries, at least according
to the, albeit limited, literature on this subject. This section surveys the few
empirical papers linking political connections to executive compensation.
Many research efforts empirically examined the link between political
connections and firm performance on a number of countries and different
time periods.15 They’ve found that political connections enable firms to
mitigate regulatory burdens, prevent market entry for new competitors,
increase their value, have a higher probability of being bailed out during a
crisis, get better loans, pay less taxes, take on higher leverage, and enjoy
greater market power and abnormal market returns. However, these papers
focused only on the impact of firm performance when their corporate boards
had politically connected executives within them. They did not look into the
microlevel data of corporate executives and how their personal connections
impact their compensations. In the United Kingdom, this was shown for the
second part of the equation: Members of Parliament benefited from their
corporate connections after serving their time in office. They were awarded
lucrative positions on the boards of companies they used to regulate.16
Although this affected their total wealth and boosted their abnormal earnings,
thus adding to overall earnings inequality, the effect is not as large as the
impact of corporate executives’ political connections.
Most studies that did examine the direct link between political
connections and corporate compensation were done in China, another
economic powerhouse with a different political system, but similar impact on
inequality. All such studies confirm the positive impact of connections on
executive compensation, either directly or indirectly. One study finds the
effect of political connections on higher earnings to hold for private firms,
but not for state-owned firms. Executives are valuable when they can provide
the necessary link to politics and benefit their companies, especially when
the owners of private firms are not politically connected themselves. In state-
owned firms this mechanism is not even necessary given that direct political
oversight already exists.17 A later study confirms these findings and also
shows how CEO political connections increase both firm performance and
their own salaries. This effect, interestingly, is found to be stronger in less-
developed regions, except if a CEO has local political connections, in which
case the regional development does not affect the positive impact of
connections on salaries.18
A more recent study on a sample of over 3,700 Chinese firms over a
period of 12 years finds that politically connected CEOs of private firms—
where a connection is specifically labeled as being part of the Chinese
“elite”—have up to 20% higher salaries than nonconnected ones, and are
also much less likely to experience turnover.19 Another recent study confirms
this effect in light of anticorruption investigations. An anticorruption
campaign reduces the within-firm pay gap. This is attributed to reducing the
agent problem in firms that are more corrupt as a consequence of their
political protection.20
 Going back to Europe, one study confirms the effect in Austria, and
another in the United Kingdom. In Austria, the authors establish a positive
causal relationship between political connections of board members of
public sector organizations and their executive compensation,21 while in the
United Kingdom, on a sample of over 700 nonfinancial companies from 2000
to 2012, the finding is that politically connected CEOs are clearly paid
higher total compensations compared to their nonconnected peers.22 A
finding with almost identical implications to the one presented in this
chapter.
Corporate executives are thus well positioned to benefit from political
connections. What about owners of capital? This group is typically examined
through the impact political connections have on their firms (which is the
subject of Chapter 7). However, one useful approximation would be to look
at a limited sample of global billionaires and a subjective but useful measure
of their political connections from Svejnar and Bagchi, mentioned in the
previous section. Their finding confirms that countries with higher levels of
inequality have a greater number of politically connected billionaires. For
example, in Canada, Netherlands, and Belgium, or in Scandinavian countries,
the authors found no billionaires that gained their wealth through political
connections over a time span of two decades. In Japan, Germany, France, and
Australia they found only one or two, and in the United States and Singapore
a handful. On the other hand, in less developed countries where politics
plays an essential role in determining large-scale corporate success, it was
hard finding billionaires who weren’t politically connected. Russia is an
obvious example with 100% of billionaires (the oligarchs) coded as
politically connected. Similar stories are found in Malaysia, Indonesia,
Thailand, India, Mexico, Argentina, Colombia, and other countries with
higher levels of income inequality than average.
What this might imply, however, is reverse causality—in very unequal
countries, wealth-seeking motives are achieved through political protection
and the violence power principle. Political connections therefore do not
cause inequality, but are a product of inequality. However, given the
historical overview presented in Chapter 2, a more convincing argument is
that usurpation of power came first, and inequality followed as a natural
consequence. Countries that lack the proper institutional incentives to curb
misuse of power are forced to witness both of these phenomena amplify each
other over decades.
 ⋆⋆⋆
This chapter untangled the direct impact of political connections on income
inequality. It showed that being a member of an elite network, representing
the collusion of interests between in-office politicians and senior executives
of publicly listed companies, affects the earnings of executives that are
members of such networks. An elite network is measured directly, by
examining the career trajectories of senior corporate executives and where
and how they intertwine with politicians. Two main definitions of
connections were used: (1) if an executive had direct previous experience in
senior government positions, and (2) if an executive is a member of the same
social group as the politician (which includes various clubs, societies,
professional organizations, church groups, trusts and foundations, charities,
NGOs, political parties, etc.).
The dataset was made using 16 years of individual-level and firm-level
data for two countries with the highest share of top 1% earnings in total
incomes—the United States and the United Kingdom—to confirm the
hypothesis that senior executives within firms do get paid a wage premium if
they are politically connected, compared to their nonconnected colleagues.
This wage premium is large and quite consistent over time. It is estimated to
be around $150,000 of total compensation in the United States and around
£90,000 of total compensation in the United Kingdom. Even though the
network effect is an important determinant of the wage premium, its main
contributors are direct connections between executives and politicians.
There is a difference between the United States and United Kingdom—direct
connections to politics via previous government experience matter much
more in the United Kingdom than in the United States. In the United States
connections via same organization membership matter more in driving the
wage premium. This suggests that in order to extract rents in the United
Kingdom in the forms of exclusive government contracts one should have
some experience in government beforehand. In the United States one is better
off in joining a social group with the politician they intend to lobby.
The findings of Chapter 4 should add yet another important but thus far
overlooked factor to the income inequality debate—the role of social
networks formed on the highest level between executives and politicians.
One of the biggest causes of increasing income inequality over the past 30
years have been rising earnings of the top 1% of income earners. Most of
these are executives of publicly listed companies, and their earnings, at least
ever since 2000, have been characterized by a wage differential resulting
from direct political connections. Elite network membership certainly pays
off.
 PART II

INSIDE THE LOGIC OF AN ELITE NETWORK

The first part of the book defined the idea of elite networks and presented the
main empirical and historical arguments of how concentration of power and
consequentially wealth within a narrow elite group widens the distribution of
income and wealth in societies. The second part will focus on specific
motivations behind each piece of an elite network: office-holding politicians
on one end of the spectrum, and corporations represented by their executives
on the other. It will thus directly build on the findings of Chapter 4 and focus
only on modern elite networks, between elected politicians and corporate
executives. Only briefly, in Chapter 5, while presenting the main theoretical
argument, will I provide examples of historical elite networks and how their
interactions generated benefits to those within them.
Chapter 5 will also present network theory and economic theory
justifications of entering into elite networks. It will show why these networks
exhibit particularly high levels of betweenness centrality and assortativity
(homophily), and why this makes them highly topocratic as opposed to
meritocratic, where wealth-seeking opportunities and access to privileged
information are condensed within a narrow group. It will also show the
economic cost-benefit reasoning of when and under which conditions
individuals decide to enter such networks. Finally, in order to fully
understand why elite networks emerged and persisted, it will revisit the three
main principles of how people used to mitigate risk in order to survive—
voluntary exchange, gift exchange, and violence based on power—helping us
better understand the motivation for entry into elite networks. Centuries of
entrapment under the violence power principle made incentives for elite
networking difficult to subdue, which is why we still have forces of wealth
accumulation present today, driving up inequality.
Chapter 6 focuses on modern-day elected politicians. Their benefit from
entering into elite network relationships is to preserve their position of
power and extract rents. Rents can come in various forms: small favors,
nepotistic arrangements, places in corporate boards after leaving office,
bribes and kickbacks, and direct usurpation of office for private gains. Firm
motivation for entry, presented in Chapter 7, is also centered around
extracting rents for the firm, and strengthening the position of the executive
within the firm. Their rents are realized in the form of exclusive government
procurement contracts or favorable legislation and regulation, for which their
executives are rewarded with greater compensation, and can even include
conspiracy acts with politicians to take profits from fraudulent deals. This
chapter also delivers the crucial theoretical difference between rent-seeking
and customer-seeking firms. As long as the system is preserved via elite
networks to favor the rent-seekers, we will have adverse socioeconomic
outcomes. The remedies for such outcomes are the subject of Part III.
 5
The Internal Logic of an Elite Network

The richest people in the world look for and build networks, everyone else looks for work.
—Robert T. Kiyosaki

The first chapter introduced the concept of elite networks and defined them
as mutually beneficial interactions between political and corporate elites.
Top corporate executives form very close friendships or connections with the
key decision-making political leaders. Both parties extract some form of rent
for themselves. Firms get rewarded through exclusive government
procurement contracts (like Odebrecht’s major infrastructure projects across
South America), subsidies, favorable regulation, and legislation (like finance
industry lobbying in the early 2000s), or can even take bloated fees for
brokering deals (like Goldman Sachs in the 1MDB scandal). The corporate
executives who made the connection are rewarded with higher salaries and
bonuses, as shown in Chapter 4, and solidify their stature within the company
hierarchy.
Politicians also benefit from such relationships. In developed
democracies they draw greater campaign donations, or are rewarded with
lucrative postcareer positions, typically in corporate boards of the firms they
used to regulate. A good example is former US Senator Evan Bayh, who
earned $3.8m for sitting on four corporate boards, one of which was a bank
that received considerable bailout funding for which he voted while a
senator.1 In less developed democracies, where institutions are personalized,
corruption is high, and accountability low, politicians take direct bribes and
other favors, and very often bind their corporate friends in a strong
interdependent network making sure that everyone within the network loses if
the central hub—the office-holding politician—loses their seat. A network of
powerful people has a strong incentive to preserve their central connecting
hub.
Joining powerful networks is legitimate. People have every right to enter
into relationships that can serve or promote their interests. Problems arise
when promoting narrow interests produces negative externalities, or when it
implies breaking or bending the law. In those cases, the outcomes arising
from such relationships retard economic growth, lower economic
opportunity, and increase inequality. Very often we see elite networks
becoming too powerful, bending the laws and institutions to their will, and
completely neglecting society’s institutional or judicial constraints. When the
judiciary is merged to be a part of the political and corporate elite network,
the capture is complete. With full political capture of institutions elite
networks start living under different rules. The laws of society cease to apply
to them. They get so comfortable in misusing their position of power that they
manage to justify any behavior, from petty crime to massive corporate
scandals, from sexual predation to involuntary murder (such as in traffic
accidents). When being part of an elite network, unless your transgression
somehow hurts the network, you will avoid punishment. Enabling this
behavior constrains the majority of wealth-seeking opportunities to a narrow
group of people, thus exerting strong pressures on inequality.
To fully understand this concept, we must present a valid theory of elite
networks that includes an explanation of why they emerged and what
motivates their formation, from a network analysis perspective, an economic
cost-benefit perspective, and a historical perspective of explaining the
principles of risk mitigation when being part of the network.

5.1. Network Theory of Elites

How are elite networks formed? Mostly they arise spontaneously and
geographically dispersed around the centers of money and power, leading to
multiple different elite networks existing within a country. There is no
centralized elite network system, although they do differ with respect to
status and level of power, where some elite networks are local, some
national, and some global (like elite gatherings at the World Economic Forum
in Davos). The point however is not in their organization, but in their
systemic spontaneity of formation.
 Elite networks are social networks, forming between persons of power.
Like all social networks, they are characterized by high levels of positive
assortativity2 of well-connected agents. Elite networks are therefore
generated by highly connected individuals (high-degree nodes) who tend to
associate and cluster with like-minded highly connected individuals with
similar interests. As emphasized in Chapter 1, this makes any elite network
highly topocratic.
In a topocratic system average compensation depends on how connected
an individual is, and what their position is within a network.3 In other words,
it is the complete opposite of a meritocratic system—it matters more who
you know than what you know. An economic system of a country is more
likely to be topocratic and hence have higher economic inequality if there
exists a large number of individuals who are poorly connected and a very
small number of individuals who are highly connected. This is, in fact, what
most societies look like.
Elite networks represent the most central, highly connected nodes within
any topocratic system. Having a powerful politician (where power is
determined by the politician’s network centrality) linked to the majority of
other important nodes in a network is a necessary condition for it to succeed,
whereas having corporate executives linked to each other is a sufficient
condition. Consider a group of corporate executives attempting to organize a
cartel to achieve dominant market positioning and set high prices. They have
an incentive to cooperate and form a network between them, however the
success of their rent-seeking venture will depend on political and regulatory
approval, or more precisely, if no regulation prevents them from colluding.
The more powerful their political connection, the more likely their venture
will be successful. Special interests use lobbying and campaign donations to
reach politicians, and this is always conditional on having a direct
connection to the right politician.
Figure 5.1, showing only a portion of the huge network of over one
million individuals and politicians based on the panel analysis in Chapter 4,
showcases exactly how this looks. The big gray nodes represent the central
hubs, the most highly connected individuals (nodes with the highest degree
centrality). These are either politicians or top corporate executives (CEOs).
The bigger the size of a node, the more connected they are. The colors of
other linked individuals represent different companies and various corporate
executives within them (note that not all corporate executives are CEOs,
many are board members, presidents, or vice presidents, as explained in the
previous chapter).

Figure 5.1 Clustering of superhubs within elite networks. Each dot represents one person, where the
size of the dot is proportional to the number of connections and individual has, while its color represents
different firms. Source: BoardEx data.

The most interesting nodes are the ones with central positions within a
network, connecting several firms and executives at once. The more central a
node, the more powerful the person, as he or she may draw favors from many
firms and act as an important connector. Notice also the importance of
betweenness centrality—the number of times each node can connect other
nodes in the network. Individuals can therefore draw influence not only from
their size of connections but also from their central position within the
network (such as the big gray nodes linked to each cluster in Figure 5.1). The
most powerful ones, however, are those in between different clusters,
carrying both superior network size and the ability to connect various
individuals from distant groups (a good example is the central gray node
between the orange, purple, blue, red, and green firms).
The existence of such highly connected nodes with high levels of
betweenness centrality, particularly in positions of political power, means
they possess superior (or have privileged access to) information on potential
opportunities4 and will only process this information among their own
narrow social group. Betweenness centrality is usually considered the most
important factor in the flow of information between nodes, even between the
high degree ones. An executive with privileged access to a high-degree
politician (and vice versa) will be the first to benefit from that proximity.
This increases informational asymmetry and undermines the market
mechanism in the distribution of opportunities, making it more likely that the
distribution of wealth and top incomes will also be captured within elite
networks.

5.1.1. The Link between Clustering and Size of Networks

To understand this mechanism better we need to examine the link between
network size and clustering. Imagine a purely random network with a large
number of nodes (N = 10 million). Imagine that the average degree (the
number of links each node has) in such a network is 150. This would
correspond to each person on average being connected to 150 other people.5
This being the average number suggests that some people are connected to
only a few people, while others are connected to thousands (recall the
descriptive statistics of Chapter 4). In this very realistic scenario of average
social connections in a lower-medium-sized country of 10 million people,
the probability of any random link forming in this country is 150/9,999,999
(average degree divided by N-1), which is 1.5*10-5, or about 0.000015.
However, clustering within social networks tends to be much higher than
the probability of any random link formation. Clustering measures the extent
to which a network is closely connected, and usually real-life social
networks are very dense and have a high degree of clustered nodes. For
example, the average clustering coefficient for citations of papers in
economic journals is 0.16 on a sample of over 80,000 nodes.6 This means
that there is a probability of 0.16 for two economists to be connected in this
network of academic publishing. If publishing were a random network with
the same degree as the economic citations network (of 1.7), the probability of
a random link forming would be a mere 2.1*10-5 for the network of same size
and connectivity, or about 7,600 times smaller than in the actual network. The
clustering coefficient for web pages measuring how linked they are, is
estimated at 0.1078, while for actor networks it is estimated to be 0.79.7
Going back to the initial example, the real-life clustering within a network of
10 million people is likely to be several thousand times greater than the
probability of forming links if this were a purely random network.
This striking finding is a normal feature of social networks. Social
networks, as shown in Figure 5.1, are characterized by high levels of
clustering. However, the rate of clustering differs with respect to the degree
of a node. Low-degree nodes (those with low levels of connections) aren’t
likely to have high levels of clustering, while better-connected nodes are
more likely to be clustered among those with whom they share opinions or
social values, for example. However, the highest-degree nodes exhibit lower
levels of clustering than high-degree nodes, meaning that the relationship
between degree size and level of clustering is concave: low-degree nodes
have low levels of clustering (close to 0; these are most people in a society),
some high-degree nodes exhibit the highest level of clustering (such as any
high-salience interest group located in the two right quadrants of Figure 1.3
in Chapter 1), while the highest-degree nodes exhibit a lower level of
clustering simply because their connections span across multiple fields,
groups, or subcultures (agents in sports or in entertainment, corporate CEOs,
high-end venture capitalists, etc.). In addition, the highest-degree nodes are
also the ones with the largest levels of betweenness centrality (as is obvious
from Figure 5.1).
Taking all this into consideration it is easy to see how social networks,
because of their unique patterns of clustering and positive assortativity
among well-connected nodes, generate inequality and low social mobility:
they condense opportunities within highly topocratic networks. An elite
network is an extreme example of both of these phenomena of social
networks. They are generated by high-degree nodes who tend to associate
with like-minded high-degree nodes with similar interests, but will have
lower average clustering and much higher betweenness centrality than high-
salience interest groups for example, and hence greater opportunity for the
spread of their vast network of influence.
Figure 5.2 shows a relationship between clustering levels and degrees of
a node for group-level connections. Each point on Figure 5.2 represents a
phase transition point. At point D the degree is low, as is the level of
clustering. At point A the degree is slightly higher, as is the level of
clustering. The overwhelming majority of people belong somewhere between
these two points: widely dispersed and with only a few connections,
consisting of family, a few friends, or neighbors.8 Between these two points
people start making connections and generating clusters—they self-select
into social groups or subcultures, generate connections in schools and in the
workplace, join societies, become fans of sports clubs. Some people will be
more connected, and have a greater network of friends, some will be less,
but in general none of these two points imply significant connectivity.
After point A there are two potential paths—each increases the level of
clustering as well as the size of the network, however they result in two
different types of networks. After point B is when people start to reach
maximum levels of clustering. High-salience groups tend to form at or
approaching point B. Examples include any powerful interest group,
positioned in the right-hand side quadrants of Figure 1.3 in Chapter 1. These
are groups formed between individuals with very similar interests,
behaviors, or ideologies who are connected primarily based on network
homophily. Examples vary from political parties to labor unions, from
country clubs to book clubs, from the NRA to Greenpeace. An extreme
version, with a much lower degree would be a sect or a cult—highly devoted
and connected members, but in relatively low numbers (the curve would end
up to the left of point A).

Figure 5.2 The different phase transitions depicting the relationship between clustering and degrees
within group-level connections.
 At point C the level of clustering is higher than before, but the size of the
network is larger than on the B-path. This is characteristic of a small group
of highly connected people; basically any person who within his or her
career is considered a superstar—corporate CEOs, bestselling authors,
famous academics, or those in a directed path (one-sided connections, where
you are connected to them, but they are not connected to you)—social media
influencers, film stars, rock-stars, athletes. These people have too many
connections to exhibit high-level clustering, yet they tend to be connected to
many individuals, and hence have very high betweenness centrality.
Elite networks are more likely to develop on the C-path, rather than the B-
path. B-path type behavior typically characterizes interest groups who,
because of their high levels of clustering and assortativity, tend to fall into
the echo chamber trap. This type of social behavior is encouraged in such
groups and they have a higher likelihood of forming negative socioeconomic
outcomes. This is the key difference between interest groups in the classic
sense and elite networks: the level of clustering is lower, degree size is
higher, and betweenness centrality much higher for members of elite
networks, meaning that their potential influence is greater. Their members are
always the most important nodes in any network.

5.1.2. The Centrality of Elite Network Superhubs

In her book Superhubs, Sandra Navidi explains the immense power of
financial elite networks. She uses the term “superhub” to describe the central
nodes of a network that carry the greatest networking power, and by
extension the greatest economic power. She limits her analysis mostly to
financial institutions containing some of the most well-connected and
powerful individuals in the world. Superhubs are extremely valuable to their
companies as they almost guarantee their dominant market status.9 The CEO
superhub of a financial institution is a typical example of an executive from C
hapter 4 in terms of their effect on the dispersion of earnings. Their value to
the firm is due to their immense network and their political connections, for
which they receive lucrative compensation packages. The more powerful the
network, the better the information a person is exposed to, which works to
solidify their position/status and their wealth. Every superhub in finance is
highly interconnected with every other superhub. Through these connections
they share privileged information and access to opportunities, thus
solidifying the topocratic nature of their elite networks.
An elite network knows no checks and balances. It is not a mechanism that
can be regulated because it is not a typical organization. It is a relationship
between friends, many of whom are extremely powerful and can be depended
on for crucial political or business decisions. Such powerful networks are
self-sustaining—being attached to one is a desire of those who wish to
emulate the same level of success and power. This persistence makes elite
networks even more powerful and influential.
As networks grow in size (and by extension power and wealth), each new
node wants to be connected to the most powerful (well-connected) node.
This tendency benefits the best connected and most senior nodes, increasing
their power even further, making them indispensable to the network (like a
pyramid scheme, where the ones on top get the most money). This happens in
both business and politics, whenever there is considerable power given to a
single individual. A highly connected person, the highest degree node,
becomes too powerful and too important. Removing this person would
render a cascading effect down the entire network, which is why each node
within the network, particularly those closely connected to the central node,
has a strong incentive not to allow the person to lose their position (unless,
of course, they themselves can replace the central node). This is especially
true in corrupt political networks, where every corrupt node is linked to the
central decision-maker—the elected official—and has a powerful incentive
to keep them in power. They will donate to campaigns, organize fundraisers,
or act as direct brokers to engage more voters. Their existence is jeopardized
(Maslow’s basic needs of security are endangered), so they fight hard to
protect the central node.
The logic of clustering and homophily is also true for corporate networks,
particularly in finance. This is why companies like McKinsey or Goldman
Sachs seek to push their partners or senior executives into high-ranking
corporate and government positions. From those positions the well-
connected individuals can benefit their former employers. All of this is
perfectly legal, bribes are unnecessary. Firms obviously do benefit from
casting a wide net of their former employees to various other corporate
positions. These employees have no obligation to benefit their former
companies, nor is this ever explicitly asked from them. The reason they do so
is their friendship links, the homophily effect. In business you like to work
with people you can trust. If these are your close personal connections, all
the better.
This is not a negative consequence of some deep systemic fault. It is
natural human behavior. We trust our closest friends and connections, and
choose to work with them whenever we have the opportunity. During the
height of the 2008 panic on financial markets, the three men in charge,
Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke, and New
York Fed Chairman Timothy Geithner trusted each other and relied on
personal connections from their former jobs—mostly big bank CEOs (see
more details in Chapter 7). It is hard to accuse them of collusion or justify the
moral outrage simply because they were asking their friends for advice. This
is a natural reaction, particularly during times of panic when quick and
important decisions need to be made. You talk to people involved, most of
whom are your personal friends, and try to find a solution.
The problem, therefore, is not network homophily or clustering, because
these are natural occurrences. The problem lies in granting too much
decision-making power to certain positions. Individuals at the helm of these
positions are prone to typical human errors and cognitive biases, or are
prone to emulating typical human behavior—in this case, the idea that you
ask people you trust what they think should be done.
It is normal for executives and politicians to network; this is, after all, the
key requirement of their careers. In this networking they get closer to each
other and rely on each other. The network bonds only grow stronger over
time, and this always benefits the most highly connected individuals, meaning
that the distribution of wealth at the top is necessarily getting more and more
concentrated. Solving this problem does not necessitate eliminating the
motivation for networking, as this is impossible. It implies lowering
motivation for elite network membership by lowering the scope of political
power.

5.1.3. Historical Examples of Elite Networks

The main focus of the book are modern-day elite networks, today more
closely connected than ever before due to the impact of technology on
information flows and the levels of globalization. However, the mechanism
of an elite network effect that causes betweenness centrality and assortativity
among its members is hardly different today from what it was throughout
history.
Examples are plentiful; from 17th-century French establishment elites
building powerful alliances based on friendships and proximity, to 15th-
century Italian financial firms seeking to be connected to politics and the
pope in a complex array of competing city-states, to 18th-century British
nobility and capital owners being closely connected to the Crown. None is
more emblematic however than the level of influence reached by the 19th-
century Rothschild family, establishing themselves as the most powerful
family in finance and banking of all time, purely due to their impressive and
wide-reaching network of connections to rulers and all other powerful
people in imperial Europe. In fact, according to Niall Ferguson’s detailed
biographic overview of the Rothschilds, they were not just the biggest global
bank that dominated the international bond market, they were also a factor of
stability in international finance, without whose support it was impossible to
wage wars or make major political decisions (the analogy for today is
imagining a merger of the top four biggest US banks, the Federal Reserve,
and the IMF into one body).10 It was an elite network where the financiers
were arguably more powerful than the rulers. Ferguson doubles down on this
claim in his book The Square and the Tower, explaining how the industrial
and credit networks built by the Rothschilds were much more effective than
the hierarchical imperial orders of 19th-century Europe. Even when
compared to the Saxe-Coburg-Gotha noble dynasty, which gave rulers to
almost every European Empire at the time, the Rothschilds carried greater
political clout.11
Unfortunately, not a lot of data exist that can be used to visualize these
networks and make inferences about their impact. There are a few exceptions
that cannot provide much depth over the inferences but can be helpful in
visualizing how elite networks used to look in history, in times of kings and
noble families, before they started implicating corporate bosses and elected
politicians. I present an example of each, the royal network centered around
the 16th-century Spanish Crown, and a network of connections of a noble
family in 18th-century Scotland. I use the datasets assembled by the
Visualizing Historical Networks project of the Harvard Center for History
and Economics (2020).12
Figure 5.3 A network of privileges granted by the Spanish Crown to colonize new territories. The two
monarchs granting the privilege were King of Spain and Holy Roman Emperor Charles V, and his wife
Queen of Spain and Holy Roman Empress Isabella of Portugal. The size of the circle depicts the
number of privileges over new territories gained by each individual. Source: Cachero, and Rodriguez-Mo
drono (2022) and the Center for History and Economics, https://histecon.fas.harvard.edu/visualizing/privi
leges/index.html.

The first is a visual representation of the privileges given by the Spanish

Crown for the colonization of the New World. It is centered around King
Charles V and the individuals he granted the rights to settle, populate, and
evangelize new territories. The project uncovering this relationship found
over 500 privileges given to 250 individuals for colonizing the new territory,
13 and drew them on a map of interactions, shown in Figure 5.3. The size of a
node in the network depicts the total number of privileges an individual
received, while its color depicts the territory over which the privilege was
granted (as shown in the legend). The central node on the right part of the
graph is Charles V, while on the left is his wife, Isabella of Portugal, who
was the regent of Spain due to Charles’s frequent travels throughout Europe,
meaning that she was in charge of the kingdom while he was away.
Both of them represent important central nodes, granting privileges to
individuals close to them. What is interesting is that individuals negotiating
between both sovereigns got greater privileges over new territories than
those connected only to a single one. Given that King Charles was often
absent, leaving his wife as the regent, waiting for him to come back would
result in gaining less privileges then if simultaneously courting his wife,
Queen Isabella. As emphasized earlier, the betweenness centrality of these
nodes was the key feature that made them more powerful and gained them
higher privilege. The entire network is an elite network, but its most
powerful individuals, apart from the king and queen, were those in between
them, the proper elite network superhubs. A good example were the members
of the Welser family, a German banking family from Augsburg, who were
financiers of Charles V,14 but even in his absence managed to accumulate
significant wealth from the colonization of the New World. The main reason
for this was their high level of betweenness centrality.
The second example shows network connections of the Johnstone family,
a noble family in 18th-century Scotland, drawn based on a book The Inner
Life of Empires by the British historian Emma Rothschild.15 A large family
of seven brothers and four sisters, with a network spanning across their close
friends, like famous philosophers, judges, or other noble families, rose to
high stature in British society during the height of the British Empire and the
expansion of the Atlantic slave trade.
Figure 5.4 shows the intricate web of connections of the family including
their friends, their business associates, and even their slaves and servants.
The members of the Johnstone family are green, the rest are in red. The links
between the nodes are also colored differently, based on different types of
relationships. Personal relationships (friendships) are red, professional are
green, family are purple, acquaintances are blue, while the relations between
slaves and their owners are yellow. The size of the node is proportional to
their level of interconnectedness, and hence importance in the network.
A few interesting relationships come to mind. First, notice close personal
relationships between some of the brothers and the most famous Scottish
philosophers of the time, like Adam Smith, David Hume, or Adam Ferguson.
William Johnstone, for example, studied with Adam Smith in Edinburgh, and
later went on to become one of the richest men in England, marring an
English heiress Frances Pulteney (taking her family name, tying him to her
estate), and being a Member of Parliament for 36 years (in the 18th century,
only the nobility could be Members of Parliament). He owned property all
over the world and was engaged in the slave trade. It was, much like the
Tammany Hall machine of 19th-century New York, a merger of politics and
business into one. His brother George, a naval officer, also served as a
Member of Parliament, was a governor of the British colony of West Florida,
and was heavily involved with the British East India Company. John
Johnstone was the second-richest member of the family, earning the most of
his fortune also within the East India Company, living for 15 years in India,
in charge of the Company’s Persian correspondence. At least four members
of the family were all connected or worked at the East India Company,
solidifying the elite network relationship between the Crown and its nobility.

Figure 5.4 A network of connections of the Johnstone family, 18th century, Scotland. Source:
Rothschild, E. (2012)

Both of these networks are typical examples of premodern, nobility-based

elite networks. Highly clustered and centered around the ruler, or with high
levels of homophily connected to other powerful and respected men of their
time. Political and business functions condensed into a few powerful high-
degree nodes with particularly large levels of betweenness centrality. Even
though political systems changed, the essence of an elite network remained
the same: powerful and wealthy individuals connected to other powerful and
wealthy individuals; in the premodern age centered around the rulers, today
centered around the most important office-holders. And in each case, the
heavily clustered elites condensed the majority of wealth gaining
opportunities within their own networks.

5.1.4. Incentives for Firms and the Impact on Inequality

Are all these network theory implications rooted in empirical conclusions of
the literature? Certainly. Many empirical findings suggest that politically
connected individuals, and by extension their firms, incur excess benefits
from their favorable position and proximity to power.16 On the other hand,
the literature also suggests that such benefits come at a cost for the connected
firms—they shift their activities and resources from satisfying customers to
lobbying for political favors, they are discouraged from investing in new
technologies, and they have no incentive to acquire top talent to keep their
business growing. One such research uses a sample of 8,000 firms in 40
developing countries to measure direct costs of political influence.17 It finds
that politically favored firms are less likely to invest and innovate (engage in
R&D, restructure operations, open new plants or production lines), which as
a consequence lowers their productivity and sales growth. Regardless of
their privileged position that renders them substantial benefits (such as
protection from expropriation, regulatory and tax benefits, or better access to
finance), politically connected firms have disincentives to innovate and are
therefore worse performers that nonconnected firms.18
As one potential extension to this mechanism proposed in the literature, I
classify the politically connected firms as rent-seekers (or rent-extractors),
and nonconnected firms as customer-seekers. The distinctions between the
two are presented in greater detail in Chapter 7, with the emphasis on how
firms benefit from elite network connections, but for now just a few main
characteristics. The difference between the two types of firms is their focus
of interest: do they reward executives for their political connections or do
they reward executives for market innovation? The customer-seeking firms
have to constantly improve their product space in order to remain present on
the market, whereas rent-seekers have lesser incentives to innovate and
compete for customers, as they can count on political rents. Rent-extraction
implies either classic rent-seeking: protectionism, barriers to new entrants,
and privileged status,19 or receiving fixed procurement contracts and
subsidies.20 In the case of privileged status and barriers to new entrants this
means that rent-extracting firms get to keep their large market share and
therefore still realize revenues through gaining customers, but would not be
able to do so without the help of political power.
It should be noted that the definitions of innovation and investment here
are not confined only to the implementation of new technologies. Innovation
and investment imply regular competitive-based activities of firms:
introducing better sales techniques, better positioning on the market, constant
improvement of the quality of the product or the service based on customer
feedback, and most importantly attracting and hiring top talent to ensure the
company’s long-term success. Lack of such incentives to innovate and invest
will shift the hiring decisions in rent-seeking firms toward executives who
are members of elite networks that could benefit the firm. This mechanism
can also work in reverse—the executive who has already self-selected into
an elite network pushes the firm to become a rent-seeker in order to
showcase his or her strength. The connected executive is generating benefits
to the firm by securing favorable regulations or exclusive government
contracts, and consequentially demanding higher compensation.
This extension is important in trying to address the reasons behind top
executive income growth. The most basic interpretation of the inequality
literature focused on firm-level analysis is that the rise in top incomes is
mostly a within-firm phenomenon. In other words, the widening disparities in
earnings between the executives and the workers were the main driver of
inequality. However according to a recent paper21 using extensive
microlevel data for the United States, the main driver of inequality seem to
be differences between firms, rather than within firms.22 The entire increase
of inequality for the bottom 99% has been driven by between-firm inequality,
and almost all of the increase of inequality of the top 1% has also been
driven by between-firm inequality (except for those in the top 0.02% of the
income distribution). The authors suggest that a possible explanation could
be the clustering of high-paid workers in more successful firms and low-paid
in less successful ones.23 The question that remains unanswered is the
composition of these clustered high-paid employees, specifically their
connections to politics. Could between-firm inequality also be driven by
rent-seeking motives of corporate executives?
 My hypothesis is that the decision to hire workers and thus enable the
observed clustering effects is contingent on how a firm survives on the
market (i.e., how it realizes its revenues). If it survives by extracting rents on
the political market it is indifferent in hiring workers to boost its
productivity, but it will hire well-connected executives to extract rents.
Therefore, an obvious distinction between a rent-seeker and a customer-
seeker is how well-connected their top executives are to politicians, and
whether they are members of close networks with the politicians in power.
This is how I define the indicator variable of political connections as used in
Chapter 4. A politically connected firm will have top executives with deep
links to politics, i.e., CEOs and board members who used to work at top-
level government jobs and who are direct members of the same social
networks as the politicians in power. The clustering of highly connected
individuals in the biggest firms explains the abovementioned between-firm
effect on the rise in the dispersion of earnings. In general, both the within-
firm effect found in Chapter 4 and the between-firm effect found in the
literature are parts of the larger elite network effect.

5.2. Economic Theory: Costs and Benefits of Elite Network

Membership
Thus far I have mostly discussed the advantages of elite network
membership, taking it for granted that it represents a stable equilibrium for
each agent to join the network and never deviate from it. However, costs of
membership certainly exist and may not be low. Costs include reputation,
effort, the threat of prison time if the activity is illegal, and an additional cost
of losing elections for the politician. In order for an individual agent to join
an elite network the benefits of membership have to outweigh the costs.
Figure 5.5 Cost-benefit graph of joining an elite network for an individual agent. The decision to join an
elite network happens between points and , when marginal benefits outweigh marginal costs
.

This logic is shown in Figure 5.5, representing the cost-benefit structure

of elite network membership with respect to the total amount of units
consumed (think of them as money, goods, and services gained through rent-
seeking) when part of an elite network. It also shows the marginal costs and
marginal benefits functions in the lower panel, while the absolute costs and
benefit functions are shown in the upper panel. The cost function for each
individual agent (dashed line) is concave up to the point , after which it
becomes convex. It reflects the idea that costs initially grow at a diminishing
rate. Initial effort and reputation are sacrificed to enter the network. These
entry costs are high, but once they are realized, further consumption of elite
network benefits does not imply great additional effort or threats to
reputation, at least until point , when by assumption most benefits enjoyed
by agents are not (yet) illegal. Hence marginal costs (also dashed line)
decline at a steady rate until point , where they reach their lowest value.
After further greater consumption of rent-seeking units, and after agents
start getting involved in illegal activities, costs of elite network membership
exponentially increase the threat of reputation, particularly under the
possibility of a prison sentence. After point , the costs have gone up too
high, and this small margin is the level at which an individual is punished
(e.g., by going to prison24). At point is where the marginal costs
significantly exceed marginal benefits.
The benefits function is convex at first, reflecting the idea that the
benefits of elite network membership have to increase exponentially to
attract individuals inside (e.g., earning more money to afford a better
lifestyle). Once the consumption of units reaches point , more exposure to
the network still increases benefits, albeit at a diminishing rate. At this point
the marginal benefits from elite network membership are highest. Once the
initial thirst for a different lifestyle has been satisfied, additional units do not
increase marginal utility as fast as before.
The equilibrium conditions are given in the lower panel of Figure 5.5. An
agent decides to join an elite network only when his or her marginal benefits
exceed his or her marginal costs of membership ( ). Because of the
specific shapes of the total costs and benefit curves we have two equilibria
for which marginal costs equal marginal benefits, and . A decision to join
an elite network happens only between those two points.
It is interesting to notice that the decision to join an elite network happens
even when (costs exceed benefits), at least after point . Before point
an individual knows that a substantial effort is necessary to become part of a
network as there is a limit to how many units he may consume. In other
words, an individual is not high enough in the hierarchy to even have an
opportunity to join the network, so any costs of effort in trying to get in
significantly outweigh the benefits. This may change in a dynamic setting, as
agents may expect to climb up the hierarchy once a part of the network.
Therefore after point , after a certain effort has been invested (going to
social gatherings and meeting the “right” people, earning a large sum of
money, winning an election, or gaining more experience that enables a person
to climb the corporate hierarchy and therefore meet the people with power),
marginal benefits start exceeding marginal costs, making it attractive for a
person to join the network, even if the total costs temporarily exceed total
benefits (e.g., paying a high initial price to cater to a politician, the benefits
of which will only be visible later). Soon enough the agent will start gaining
marginal utility, for which total benefits will exceed total costs,
happening after point .25 This situation will last only until point , after
which, despite still receiving benefits from network membership, the
marginal costs start to exceed marginal benefits. In colloquial terms, the
agent is “in too deep,” as there is an increasing likelihood that the activities
of the group might be uncovered and that punishment will occur. Finally, after
point , costs again outweigh the benefits as the agent is punished for illegal
activities. At this point membership in an elite network stops.
An extension to this setting would be to model the within-network
relationships of agents. Not all agents are the same, nor are they valued the
same way in the network. Some carry more influence than others (although
this obviously changes over time), so to adjust for this I would have to draw
different cost-benefit curves for different agents depending on their network
centrality (how important they are in the system). Even though I assume, for
simplicity, that all agents that engage in the network are equally important as
each of them is driven by an incentive to pursue their interest, it is safe to
assume that the theory holds for both high-degree and low-degree nodes. In
other words, each node will only join if his or her expected benefits are high
enough.
For example, when high degree nodes reach their central position in the
network, their costs are certainly lower and benefits much higher, but in
order to build a position of the central node it takes time and a lot of effort,
hence the costs of getting there are still significant. Before they reach their
level of centrality and can extract the maximum benefits from point M
onward, they have to go through the period, when their costs are high and
benefits not immediately obvious. Every person with even the slightest
experience in networking knows this. You make connections without
immediately being aware how they might benefit you in the long run. Many of
them never do, but as you amass a greater network, get connected to more
people and extort a significant effort in doing so, over time, if you persist in
your efforts, you find yourself as a central node with greater abilities to
connect people than before, and greater opportunities to benefit.

5.3. Joining Elite Networks to Mitigate Risk and Achieve Stat

us: The Three Principles
The previous sections explained the network theory and economic theory
justifications behind elite network formation, and why this would affect
inequality. To close the circle behind explaining incentives for membership
we need a historical context of how humans formed mechanisms of mitigating
risk and achieving status. As mentioned in the Introduction and throughout Ch
apter 2, we can boil it down to three principles of how people secure their
existence and status, both today and throughout history.
Securing one’s existence is at the very bottom of Maslow’s pyramid of
needs. It is just above the basic physiological needs (food, water, sleep,
reproduction), making it a very important motivational factor for each
person. Securing existence means mitigating risk. In any point in history, the
risk of being subject to some form of violence was high. Opportunities for
making money and achieving any form of above-subsistence living standards
were scarcely available to anyone outside the top 10% of the wealthiest
population, until basically the second part of the 20th century. During the
Middle Ages for example, one way to escape Malthusian subsistence was to
go to war, like the Crusades, and rob and pillage your way to some wealth.
Still, most of what was stolen would end up with the nobles under whose
flag you fought. To become part of an elite network was incredibly difficult
for anyone not already being born to a family of means. But even these elite
networks had to have had an origin. Just like the rulers of the first proto-
states, as described in Chapter 2, the rise of the nobility, the second part the
network, had to have been rooted in some motivational factor, besides just
being in proximity to the ruler. To understand what it was, let us build on the
three principles of satisfying Maslow’s needs, as described in the
Introduction: the voluntary exchange principle, the gift exchange principle,
and the violence power principle.
The first principle, voluntary exchange, implies that people satisfy their
existential needs by exchanging goods and services on a voluntary basis,
without coercion, and based on consensual institutions and rules agreed on
by all actors (like exchange of money or other means, legal contracts, social
contracts, etc.). In the modern age such institutions are purposely designed
and provided as public goods (protection of human rights, legal system,
monetary system, market regulations), but throughout history the institutions
necessary to promote voluntary exchange arose spontaneously. The
motivation to exchange surpluses with other members of the community
originated with the Agricultural Revolution. As described in Chapter 2, the
first proto-states emerged as a system to protect surpluses from roving
bandits, replacing them with stationary bandits and the first hierarchical
power structures. However, the hierarchical structures gave little
institutional support to promote free exchange, which is why economic
growth was severely constrained, but the impulse to trade and exchange
goods voluntarily was nevertheless present in all societies through all ages.
Human existence was always contingent on various forms of organized
societies, which determine rules of how collective decisions are being made.
From the primitive tribal systems to modern states there was a search for an
efficient and functional form of political order as a medium of making the
right collective decisions: from autocracies to various forms of democratic
orders whose institutions become more and more inclusive. History teaches
us that the rise of liberal and democratic institutions, ascending in parallel
with the adoption of the voluntary exchange principle, enabled the greatest
progress and growth of wealth in human history, the largest amount of the
world’s population escaping poverty, but also the largest demographic
expansion in history of mankind.
We can arguably claim that societal development depended on how the
voluntary exchange principle was adopted. When it was protected and
encouraged by spontaneous social norms, societies flourished. When it was
subverted by autocratic rulers or periods of war and uncertainty, societies
regressed. During the long period of gradual adaptation of democratic norms
and institutions in the post–Industrial Revolution era, the free exchange
principle was finally getting supported by proper institutional incentives and
protection. It took a while for those institutions to yield their full effect (as is
described in greater detail in Chapter 8), but once they did, it allowed
societies to finally reap maximum benefits from the principle of free
exchange. Governments were switching from despotic autocracies to
inclusive democracies, they were limiting the motivation to engage in
coercion and violence, they made sure that property rights were respected,
that human rights were protected, and that people could feel safe. The
superiority of the free exchange principle is also visible through much more
efficient usage of human resources. Having the freedom of expression
encouraged social mobility and inspired talented individuals to fulfill their
potential, rendering massive positive impacts on innovation in business,
science, and art, much more so than ever before in history.
The voluntary exchange principle was therefore an omnipresent
motivation for securing one’s existence, but it was not until the 20th century,
enabled by the historical factors responsible for the rise of inclusive
democratic capitalism, and protected institutionally via all the necessary
public goods, that the principle yielded maximum benefits for societies.
People could finally resort to voluntary exchange to secure their existence
without being afraid of coercion, or without having to be drawn to elite
networks. Elite networks persisted as well, preserved by the forces of
wealth accumulation, and still promoting unequal distributions of wealth and
income, but they no longer subvert voluntary exchange for all individuals.
The second principle, gift exchange, has also been a persistent factor
throughout human history. The gift exchange culture was even found to be a
predecessor of voluntary exchange, where people in close knit communities
exchanged goods as gifts. During ancient times, throughout the Middle Ages,
and even during the Enlightenment period, the gift exchange principle was
adopted through the patron–client relationship, where wealthy individuals
would fund artists or explorers. Today, in the modern age, this principle is
maintained in the form of philanthropy and through various charities and
foundations that are often indispensable in financing universities, think
thanks, and the arts; fighting diseases; or promoting other cultural and social
issues. Such organizations are not usually present on the market, nor do they
necessarily get funded by governments. They depend on gift exchange, where
the donor receives benefits in such an exchange through improved reputation,
prestige, or simply the feel-good factor.
Another form of the gift exchange principle is inheritance. Sometimes
inheritance fortunes can be used to promote the aforementioned philanthropic
activities, but much more often inheritance has been a transaction limited to a
family unit, particularly since inheritance fortunes were not large for the vast
majority of the population. Inheritance is a good example of an altruistic
exchange, not driven by market mechanisms, and not imposed by
governments (it is regulated by governments, but not imposed). It serves the
purpose of solidarity, where parents and children take care of each other in
various stages of life, and parents have an internal motivation to leave
something for their children after their passing. It is a natural tendency that
requires no outside enforcement.26 The problem is when inheritance itself
becomes the source of inequality, in instances where a large fortune is given
to the benefactor. The main issue is with regard to the origin of the inherited
wealth. If it was created based on the free exchange principle (e.g., fortune
created by an entrepreneur whose wealth was attained without coercion and
based on voluntary market exchange), where the benefactor must preserve the
wealth via the same principle, it can be considered just.27 If, on the other
hand, it was created based on proximity to political power or through
violence, then the inheritance itself is unjust and deepens inequality.
This brings us to the third principle of securing one’s existence: the
violence power principle, the key motivation for elite network membership
and usurpation of power. This was a principle always applied by a minority
of individuals who had the legitimacy of using coercion over others. The
usage of violence, robbery and pillaging of property, or coercion of people
into slaves was a dominant pattern of behavior throughout human history until
the modern age. It was a successful risk-mitigating strategy. Being in power
or in proximity to power was in every society in history a much better
strategy than being subjected to the whims of those with power. Using
violence and coercion as methods of gaining wealth and securing one’s
existence was a much more successful strategy than resorting to voluntary or
gift exchange. For one, the costs and risks of using violence were lower than
the anticipated benefits. There was no universal and morally acceptable
punishment of violent transgressors, provided that these transgressors held
any kind of power. There were no human rights that protected the population
from being coerced at will by their rulers. The risk of theft or pillaging was
also low given that the population being coerced had no way to successfully
defend itself against armies or guards without weapons. Societies where
violence legitimized by power is seldom punished yielded a minority group
that used violence to ensure its existence. This was the origin of an elite
network: everyone with a legitimate claim to power (kinds, nobles, the
clergy) used coercion to secure their existence and ultimately status.
It is no wonder that societal elites attempted to preserve their position and
make it hereditary and permanent. It was the most optimal way of securing
one’s existence and did not include the uncertainty of hard labor, or having
the products of that labor violently destroyed. There was little way for
anyone to disrupt an elite network from the bottom-up. The only way for
someone to lose privilege was to have a falling out with the ruler (losing the
benefits given by proximity to power), be deposed by a mutiny of other
nobles or pretenders to the throne, or to be deposed by an outside threat in
the form of an enemy army (like the Huns for the Roman Empire, Mongols for
China and Asia, Vikings throughout Europe, etc.). In short, the usual way of
ending someone’s position in an elite network was death. There certainly
was a risk of elite network membership, but that risk was tied to the limits of
sovereign power (both internal and external).
This molded political and economic institutions in societies with a clear
goal of strengthening extractive political power. Religion was used as an apt
justification of the divine right to hold power, which is why the clergy class
also enjoyed elite network privileges. This is how societies were organized
for several millennia, ever since the dawn of ancient civilizations, up until
the modern age, with very seldom and secluded exceptions. Slavery
societies, feudalism, or modern-day despotism all had the same internal
structure and motivation. Slavery was a normal condition, widely accepted,
as was the idea that any ruler had the perfect legitimacy to murder, pillage, or
otherwise coerce anyone else in society. An obvious consequence to this
uncertainty and elite power capture, encapsulated by the violence power
principle, were Hobbesian living standards, a long-term Malthusian trap, and
the perpetuation of the forces of wealth accumulation yielding constant
upward pressure on inequality.
Societies did manage to gradually change. It took several critical
junctures in human history for things to start moving in a different direction.
One of these was the Black Death plague in the 14th century, followed by the
transitionary period of the Renaissance in the 15th and 16th centuries and the
Ages of Discovery. Another was the invention of the printing press in the
15th century, which enabled a faster spread of new ideas via books and for
the first time allowed people in Europe to express themselves differently and
pursue their happiness outside the confounds of the traditional Malthusian
trap. The stage was set for the Enlightenment era. This embraced the Church
as well, with the Reformation movement having the goal to bring the
Christian doctrine closer to everyday life, thus endangering the monopoly of
the Catholic Church, itself operating under the violent power principle
throughout the Middle Ages (Crusades, inquisition, conquering territories by
the papacy, etc.) This further encouraged the competition of religious ideas
and gave rise to the free exchange principle as an alternative to the violence
power principle.
The emphasis on individual freedom started replacing the dominant
coercive collectivism, which signaled a prelude to the Industrial Revolution.
28 Despite these initial major disruptions, from the Enlightenment, New

World discoveries, all the way to the Industrial Revolution, every state was
still guided by the violence power principle well until the 20th century. But
the change in rhetoric and the perception of individual freedom that
motivated 18th- and 19th-century revolutions spurred century-long
philosophical and political economic debates on the limits of state power
that carry on until today.
The voluntary exchange principle finally won over in the second half of
the 20th century, becoming fully adopted in at least one part of the world, the
one embracing democratic capitalism with a reinvented role of the state in
providing public goods, and no longer relying on violence and coercion (the
other part of the world started adapting the same some 40 years later). The
violence power principle was subdued but was never completely eliminated
from human behavior. It is difficult to completely disrupt a principle that has
guided and motivated human behavior for centuries, even millennia, always
latently present within societies, lurking for an opportunity to manifest itself.
Whenever a society starts to disintegrate during a crisis, the latent violence
power principle starts to resurface. Calls for autocratic (typically populist,
one-size-fits-all) solutions are particularly vocal in times of crisis, when
many people feel under pressure and experience hopelessness, thus turning to
simple solutions. The most recent example was the aftermath of the European
sovereign debt crisis, which saw a dangerous move toward authoritarianism
in many European countries, typically as a result of internal demand of the
population.
Full re-emergence of the violence power principle rooted in predatory
behavior, lawlessness and destruction thankfully did not materialize, but its
motivation is omnipresent. It will take a lot of time living under peaceful and
prosperous conditions, driven by rapid technological progress to fully
subdue this latent driver of human behavior. The current rate of societal
progress, empowering and enriching more people than ever before, and at a
faster pace than ever before, is the main reason for optimism that societies
could finally break away from the violence power principle, forever limiting
it to the fringes of society. In order to help them achieve this, a proper set of
reforms aimed at lowering political power and empowering the citizens,
described in detail in the final chapter, should be implemented. Only after
eliminating the violence power incentives can we hope to eliminate the
motivation of the elites to capture and misuse power and solve the issue of
unfair distribution of incomes.
⋆⋆⋆
Elite networks have been persistent throughout history, and the motivation for
joining them, rooted in the violence power principle has always been
present. People could secure their existence if they were engaged in
voluntary exchange or if they were granted a gift, either from a patron or in
the form of inheritance. However, securing one’s existence in either of these
two ways was, throughout history, riskier than the violence power principle.
The reason is because it lacked any institutional protection. There were no
rules guiding it and people were subject to unpredictable forces (often of
nature), or at the mercy of roving or stationary bandits. One could lose their
entire property, wealth, and family without any protection whatsoever. This
is why the market exchange principle needed a strong set of institutional rules
to make it work and deliver the greatest benefit to society. It was only then,
when governments started to provide a system that helps foster market
exchange, that the greatest levels of economic progress were achieved. The
progress of our societies finally happened when we learned how to subdue
the violence power principle. But it was never entirely destroyed.
What we have today is still a threat of elite networks usurping power,
pushing up inequality and constraining opportunity. The motivation of joining
them is still strong, even though being part of an elite network today does not
grant you the same legitimacy to use violence or coercion as it did in the
past. But it does give you access to unique information and opportunities, and
enables the network effect to work to your advantage. Before presenting a
detailed overview of helpful reforms in the third section, culminating in Chap
ter 10, we must first see how the violence power principle still exists in the
modern world, no longer being used to murder or destroy, but still strong
enough to motivate both politicians and firms to extract rents. This will be
shown in the next two chapters: Chapter 6, which looks at the political
motivations and benefits of elite network membership, and Chapter 7, which
looks at the same for the firm.
 6
Motivation for Politicians
Extracting Rents and Staying in Power

Ninety percent of the politicians give the other ten percent a bad reputation.
—Henry Kissinger

Now that we understand why people enter into elite networks, we can
examine the benefits of membership for each group. We start with politicians.
What benefits can politicians achieve by entering into such relationships? In
high- corruption countries two benefits stand out in particular: (1) avoiding
punishment if they are able to generate a minimum winning coalition of
interests, which is very often consolidated by the elite network they belong
to; and (2) the ability to extract rents for themselves, in the form of various
monetary or nonmonetary concessions. In low-corruption countries, the risk
of taking bribes or otherwise embezzling public money is too high, so
politicians receive other types of rewards. They get appointed to corporate
boards after leaving office, enjoy small favors while in office, or, in cases of
low accountability and oversight, can engage in extortion and similar
practices, and may still build powerful local coalitions to remain in power.
The political agency literature, in addition to the selectorate theory,
provides the best explanations of how this mechanism works, showing that
office longevity and rent-extraction need not be mutually exclusive. When
this is the case, a politician can stay in office for long periods of time,
supported by an elite network they’ve helped set up, contingent on all of them
receiving their share of the rent.
A more direct approach to estimating rent-extraction in the form of
corruption is also possible. A number of empirical research efforts have
been made, across several countries, that aim to approximate corruption
using fraudulent procurement contracts. When measured this way, corruption
is shown to have a direct positive implication on political re-election. This
is worrisome, but as this chapter will show, it is not entirely surprising.

6.1. Corruption, Clientelism, and Rent-Extraction

Politics is an arena for resource redistribution. It is a tool of representative
democracies necessary to satisfy the redistributive and allocative roles of
governments. It is also a tool that can be misused to promote special
interests. A big part of the political process involves using distributional
powers of executive office to fulfill personal goals of self-interested actors.
Be it those of the politicians themselves or the interests of those around them.
In their influential book Brokers, Voters, and Clientelism, a group of four
political scientists, Stokes, Dunning, Nazareno, and Brusco, deliver a
comprehensive definition of such wasteful distributive strategies, referring to
them as models of nonprogrammatic distribution. Whenever there are no
clear public criteria for distribution or when these criteria are abandoned to
promote private interests, such distribution is considered to be
nonprogrammatic. The “most toxic” form of nonprogrammatic distribution is
clientelism; a quid pro quo relationship between voters and politicians
where votes are exchanged for direct material benefits.1 In addition,
noncompliance from voters is subject to punishment, implying that
clientelism can take a form of coercion, thus inhibiting the proper functioning
of democracy.2
Clientelism, however, is not necessarily just about influencing, buying, or
coercing votes from individual voters. It can also extend to direct material
benefits, exclusive contracts, and favorable regulation given to private
businesses. The premise is the same—distributional benefits are shared to
interested actors within the same network of interests who in return promise
political loyalty. These activities however, unlike regular vote-buying
through pork-barrel spending or populist policies, are often illegal. It is thus
more precise to expose such activities for what they really are—political
corruption.3
Corruption can take many forms: (1) misallocation of public resources—
exclusive contracts are given to firms based on political connections, (2)
nepotism—a variant of patronage where public sector jobs are given to
insufficiently qualified relatives or friends, (3) bribery—the classic
compensation mechanism for any corrupt activity, (4) conflict of interest—
public servants use their connections and access to information to generate
benefits for themselves or their clients, and finally (5) institutional corruption
—the implementation of laws and regulations that directly favor private or
public enterprises.4 Therefore, according to Shleifer and Vishny, corruption
is “not some moral aberration, but a general and natural consequence of the
operations of the grabbing hand government.”5 There is an inherent incentive
for politicians holding power to design a system that maximizes rent-seeking
behavior based on close personal networks of interests.6
The key to political survival lies in the effectiveness of this network of
interests in preserving systemic corruption that enables all connected actors
to keep extracting rents. In practice this means that politicians holding power
will enter into numerous deals with various special interests from which they
can expect to receive electoral support.7 In a codependent system based on
close personal ties where concessions are traded in return for votes, bribes,
or other kind of support, those linked with politicians, who have a lot to lose
from their demise, will make sure they stay in office for as long as possible.
In such an institutional framework, well-organized ruling elites manipulate
the economy by generating privileges based on the personalization of
governing institutions. Whenever intrapersonal relationships between the
powerful and the political elites determine political and economic outcomes,
societies exhibit political capture of public institutions.8
What I am specifically interested to show in this chapter is empirical
evidence of when corruption, formed through a clientelistic elite network
type of relationship, carries a positive electoral effect for politicians. In
other words, politicians are encouraged to build and enter into elite networks
as this enables them not only to collect rents but also to stay in power. The
most accurate way to capture corruption, as shall be explained below, is to
approximate it through potentially fraudulent procurement contracts
administered by the local or national government, given to selected
politically connected private firms. The hypothesis is that due to personal
connections and mutual dependence between rent-seeking firms and the
political establishment, politicians can win elections without decreasing the
scope of their corrupt behavior. Moreover, politicians have a greater
probability of staying in power if they create an informal network of interests
that enables and encourages corruption.
 6.1.1. Political Agency
These hypotheses are drawn from the standard theoretical and empirical
findings of the political agency literature. Political agency assumes that
politicians in power have strong incentives to misuse that power for private
gain. Political accountability in front of voters (principals) should prevent
politicians (agents) from fully expropriating the public budget. However, due
to lack of transparency and an informational advantage, politicians often do
get away with allocating a fraction of public funds to their private benefit.
These activities, whether done at a local level or a grand-scale national
level, are widely known as corruption, as defined above, but in the
terminology of political agency models it is called rent-extraction.
Rent-extraction, unlike the corporate practice of rent-seeking, includes
excess payments (bribes) extracted through public good expenditures on
various pork-barrel and white elephant projects obtained by an incumbent
politician. For example, while building a road or a bridge a politician can
conceal his rent-extraction by presenting one price to the public while paying
a different (lower) price to the contractor, thus taking the difference for
himself. Furthermore, there are also instances of fraud in public
procurements, diversion of public funds (expenditures without proof of
purchase), and overinvoicing (buying goods above market price), which tend
to be more easily and frequently done on a local rather than a national level.
Rents are therefore hidden within budgetary expenditures that provide the
easiest rent-extracting opportunities—such as public investments on
infrastructure projects, IT projects, or defense spending. In each of these
cases, a politician needs close collaboration with the business owners or
CEOs, thus closing the elite network circle.
Political agency is mostly concerned with politicians as nonbenevolent
rent-seekers driven purely by self-preservation. They seek to maximize their
private benefit from holding office by implementing their preferred policies.
While providing the general public goods for the satisfaction of voter
preferences and thus generating favorable public outcomes, they have a
strong incentive to divert some of the budgetary allocation toward wasteful
spending from which they aim to extract rents. This assumption is aligned
with Buchanan and Tullock’s and Brennan and Buchanan’s definition of
politicians as self-interested utility maximizers9 or the more recent definition
from Bueno De Mesquita et al.,10 who assume that:
 … all political leaders, regardless of their institutional setting, have a common utility function that
emphasizes first holding onto (or gaining) office and second maximizing their personal income while
in office.
—Bueno De Mesquita et al. (2005), p. 21

Selection of politicians is therefore adverse and tends to produces “bad

politicians.”11 The opportunity costs of working in the market sector are too
high for high-ability individuals, so the selection of candidates into politics
will be skewed toward low-ability or corrupt individuals. Even if high-
ability citizens were allowed to enter office in order capitalize on their
prepolitical experience, there are still incentives for these individuals to
enter the political market in order to obtain private benefits, meaning they
will still engage in a trade-off with the voters over optimal policies.
Political agency models therefore describe a general setting in which a
rational agent’s maximization problem is to capture political rents.12 The
voters are unable to observe the budgetary allocation process directly,
creating the problem of electoral accountability of politicians (the monitoring
problem). Uncertainty and asymmetric information give further incentives to
politicians to misrepresent themselves and pursue their own interests. Due to
such behavior of agents, there exists a trade-off between voter utility
(policies appealing to voters) and rent-extraction (policies appealing to
politicians in power). The central issue is whether or not electoral
competition and the discipline effect of the voters will induce politicians to
announce voter optimal policies or rent-maximizing policies.
The models are often characterized by a two-period setting in which a
politician’s term ends in the second period.13 In order to stay in office and
reach the second period, an incumbent politician should limit his rent-
extraction in , since retrospective voters reward congruent behavior. The
re-election incentive should improve the discipline of politicians. However,
in the second and final period , a moral hazard problem arises since bad
politicians are free to divert the entire budget toward their private means. In
classical moral hazard models, the homogeneous voter observes the
politician’s action but with a noise. The politician observes this noise before
making his action (or level of effort), which depends on the re-election rule
chosen by the voters to limit the incumbent’s incentives for rent-extraction.
In expanding the moral hazard problem newer models introduced adverse
selection14 concerning how good politicians should distinguish themselves
from bad ones, where the first period behavior of bad politicians implies
“mimicking” the behavior of good politicians and sacrificing first period
rents in order to remain in office and expropriate the entire budget for rents
in . The probability of a politician doing so depends on his time
preference for money (the discount factor). The selection effect is added to
the discipline effect, where candidate types determine the competency of
politicians in providing public goods, or whether or not they are likely to
extract more rents. The candidate’s choice of policy will determine his type
and send a signal to voters on re-election. When voter preferences are taken
into account, things get more complicated, given that voters themselves are
far from perfect agents that punish every transgression.

6.2. Do Voters Punish Corruption?

There is one puzzle that appears to characterize electorates regardless of
their institutional background and strength of democratic institutions. The
impact of corruption on chances of re-election should by any reasonable
assumption be negative. However, the majority of the literature suggests
otherwise, leaving an open question of why voters do not punish corruption
at the polls, at least not as much as one should expect.
The empirical literature supports this worrying pattern across many
developed countries, from the United States to Japan, from Greece to Italy:
voters often fail to punish corrupt politicians by electing them out of office.15
Even when the literature does confirm a negative impact of corruption on
chances of re-election, the general finding is that incumbent politicians are
either not punished at all or not punished enough.16
The underlying assumption beneath this puzzle is that the vast majority of
voters are honest people who dislike corruption. Accordingly, they should
punish corruption when they become aware of it. But being aware of it in a
world of informational asymmetries is not straightforward. Politicians have
every incentive to hide their illegal activates, and particularly the strength of
their powerful networks, from the public eye. This has led to the origination
of two competing hypotheses explaining the conundrum of why voters fail to
punish corruption, even when they know it is likely to be present.17
These can be defined as the information hypothesis and the trade-off
(material benefits) hypothesis. The information hypothesis follows the
Downsian logic of rationally ignorant voters.18 Voters either rationally chose
to stay misinformed or they suffer from informational asymmetries.
According to this hypothesis there are two ways to overcome the information
asymmetry: (1) voters receive information from sources they consider to be
credible and trustworthy (the media would be one mechanism for closing the
informational asymmetry, however voter trust in media is selective at best),
or (2) if this information is easily accessible to all voters.19
The trade-off, or material benefits, hypothesis on the other hand claims
that voters are fully aware of the extent of political corruption in a country,
but tend to overlook it due to personal benefits they might receive (like
patronage or pork spending) and/or ideological proximity to their candidate.
This hypothesis envisions politicians in a quasi–Robin Hood fashion where
voters know they will steal, “but at least they are giving (some of it) back to
the people.” Furthermore, due to uncertainty regarding the challenger amid
adverse selection into politics, voters often fear replacing the incumbent as
they are not sure that the challenger will keep delivering the same benefits as
the incumbent, nor are they certain that the challenger won’t be even more
corrupt than the incumbent. This is particularly relevant in electorates where
voters perceive all politicians as bad.
If corrupt politicians deliver successful policies (infrastructure, growth,
etc.), if they are perceived to be of high competence, corruption is irrelevant
to the voters, and politicians can avoid punishment for years. This is one
mechanism by which corruption can become entrenched in democracies. In
one of my papers with colleagues Podobnik and Stanley, examining phase
transitions of when corruption prevails in democracies, we show that
democracies do not cause corruption but can serve as a mechanism that
preserves it.20 If voters rationally decide to be ignorant about political
corruption, or if they rationally support a known corrupt candidate, then the
mechanisms of political competition do not work, and democratic institutions
are inefficient in combating corruption.
With this in mind, the given two hypotheses are not necessarily mutually
exclusive. For example, core party supporters choose to remain rationally
ignorant about corruption and dismiss any evidence against their candidates
as politically motivated accusations from the opposition or the biased media.
In this case, ideology of a candidate and his perceived competence keep a
candidate safe from punishment. If a politician lacks competence or
likability, or if he failed to deliver the expected benefits, then voters will
punish him at first implication of corruption.
 The combination of the two hypotheses suggests that voters find both of
these factors important: competence (in terms of likability, ideological
proximity, and delivered benefits) and corruption, the importance of which is
triggered only if competence is low. Voters thus react to corruption only if the
candidate is of low quality, or ideologically distant.

6.3. Elite Networks and the Selectorate Theory

There is another factor that can amplify informational asymmetries among
voters—the existence of elite networks, which thrive on having information
skewed toward the selected few, as shown in Chapter 5. Elite networks are
formed to promote the partial interests of its members. When politicians and
firms collude to build infrastructure projects while splitting the profits,
voters receive only a partial signal—they usually cannot tell whether the
project’s inflated price was due to corruption or some other exogenous
shock. The motivation for hidden rent-extraction delivered through elite
network membership is therefore immense: rents are created and distributed
among its members, and the politician delivers a public good (in this context
the better term is public bad) for which he may be rewarded by the voters.
From the politician’s point of view, the motivation for being part of an
elite network is fourfold. First, such relationships reduce risk and uncertainty
for all connected members.21 Being part of an embedded network of interest
encourages all parties to stay in, be loyal, and protect the patron, knowing
that his demise might endanger one’s entire enterprise and its expected
revenues. Politicians count on the loyalty of their network, whose motivation
to keep him in power is greater the more interconnected they get. The biggest
risk is to lose the patron, and all members will actively seek to reduce this
risk.
The second motivation, derived from risk-aversion is the ability to extract
rents.22 As emphasized earlier, political rents vary from bribes, to various
embezzlement schemes, to receiving campaign funding. Third, being part of
the network breeds nepotism as it relies on a number of “small favors” that
vary from playing golf and getting tickets to sporting events, to directly hiring
friends and relatives of the politician in the firm as a favor to the patron.23
All actors have an incentive to perform the favor as this will further improve
trust and strengthen the ties of the network.
 This is particularly true when substantial criminal activities are involved.
The commitment device becomes even stronger in that case: none of the
actors involved in the criminal act have any incentive to voluntarily break the
network, as they know that the downfall of others could also be their own.
This makes ties within the network even more exclusive, as the group
accumulates power. Such groups do eventually break down, particularly in
institutionally well-defined democracies where punishment occurs through an
impartial legal system. In more extractive institutional environments
however, such groups can persist for quite a long time, and can be
notoriously difficult to break.
The final motivation is that elite networks embed minimum winning
coalitions that help politicians stay in power very long. To understand this
mechanism fully, we must turn to the selectorate theory, presented in the book
The Logic of Political Survival by four political scientists, Bueno De
Mesquita, Smith, Siverson, and Morrow.24
According to the selectorate theory, politicians lacking serious
accountability and media oversight can stay in power for very long if they
manage to create a large enough group of supporters they can reward with
various concessions. The group of loyal supporters that directly benefit from
their politician or party staying in power is defined as the minimum winning
coalition (W). A winning coalition is a subset of a larger group called the
selectorate (S), representing all voters eligible to vote in a society. The
smaller the winning coalition with respect to the size of the selectorate (the
so-called W/S ratio), the greater the chances of political survival. This is
due to the fact that members of small winning coalitions can easily be
replaced by members outside of the coalition if they fail to remain loyal. The
costs of defection of members within the winning coalition are too large
(they lose their privileges and benefits). This testifies to a mutually
dependent relationship between political elites and the groups they choose to
include in their winning coalitions.
In dictatorships, winning coalitions are typically made of senior army
officials which help preserve the regime, or are otherwise made up of elite
networks that strengthen the dictator’s rule and benefit themselves from
proximity to the dictator (similar to Ben Ali’s family and close associates, as
portrayed in the Introduction). In democracies, politicians cannot reward
their coalitions in the same fashion, so they resort to vote-buying practices or
offer jobs in the public service. They may also collaborate with corporate
interests where campaign donations are exchanged for favorable legislation
and other benefits, and where many politically connected firms can get
directly involved in encouraging voters (this is particularly evident in less
developed, high-corruption democracies). Democratic politicians often use
the help of key members such as union, religious, or ethnic group leaders
who can secure votes through their large membership. The leaders enjoy the
rewards, while the members provide the votes.
The logic among both democratic and autocratic leaders, however, is the
same: create a mutually beneficial and interdependent relationship with a
group of core loyal supporters who have much to lose if their politicians lose
office and thus have a very strong incentive to keep them in power. These
coalitions are very stable but they are highly dependent on a single person.
Everyone stands to lose if the central node of the network—the corrupt
mayor—loses his position. The network makes sure this rarely happens.
Environments where very small but powerful winning coalitions are enough
for the politician to stay in power for very long are more likely to have their
institutions personalized, lack any accountability toward the broad voter
base, suffer from higher corruption, emblematic clientelism, and
consequentially higher inequality, lower living standards, and very low
incentives for igniting economic growth and development.
In democracies, even developed ones, such scenarios are much more
likely to happen on a local rather than a national level, simply because of
much lower accountability existing locally. For one, not all local areas have
free media to report transgressions and local scandals. If a scandal does
occur it will rarely result in punishment unless picked up by national media.
It is thus no wonder that longevity in office in local government is highly
correlated to instances of corruption.25 The longer someone holds power, the
more likely they will successfully build their coalitions, and the more likely
they are to redistribute resources among themselves and their loyal
supporters or cronies. Local elite networks might not be as powerful as
national elite networks, but within their local environments they do hold
significant clout and can seriously undermine local development and increase
inequality.
The mechanism described by the selectorate theory is to a large extent
similar to the overreaching hypothesis of this book, with the difference that
the selectorate theory emphasizes that large winning coalition environments
(with respect to the electorate, so most democracies) will deliver beneficial
public policies, and that the creation of small powerful cliques will be
limited to autocracies or at best local levels of government. I posit that such
cliques arise everywhere, and at all levels of government. They are most
likely to be noticed and examined at a local level, however their spontaneous
emergence will characterize any system where political power can be
misused to promote partial interests.
Therefore, when merging elite network theory with the selectorate theory
we can see why elite networks are so lucrative and attractive for politicians.
They are able to turn their position of power into a machine for extracting
rents and accumulating wealth. At the same time, they can rely on their elite
network to help them keep their position, from which they all may benefit.

6.3.1. The Nonlinearity between Corruption and Political Surviva

l
The more people involved within a network of a politician’s key supporters,
the more likely that corruption will be noticed by outsiders, rendering a
nonlinear effect on political survival. How? Given that corruption is hidden,
the mechanism through which the process works could be the following:
voters are unaware of actual corruption and are only aware of rumors and
media reports. These rumors and media reports increase in intensity as the
mayor gets involved in more corrupt practices (e.g., allocates more
fraudulent procurement contracts).
The more corrupt activities there are, the more difficult it is to hide them
from the public’s eye. Voters and reporters however do not see the full extent
of corruption. They only see signals if other people talk more about them. A
mayor who is corrupt manages to deliver a substantial amount of public
goods through his cronies, and this is perceived to be beneficial by the voters
(and rewarded with re-election), as they do not notice any direct corruption.
However, as more and more jobs are distributed to a narrow group of core
supporters, voters (and reporters) do start to notice and the information
spreads.
This is why I assume a nonlinear relationship between corruption and re-
election probabilities. With corruption being measured through fraudulent
public procurements, this is not easily observed by the majority of the public,
particularly at the level of local government. A mayor easily gets away with
some small(er) level of corruption without antagonizing too many
constituents. As more jobs are distributed within the elite network, more and
more local constituents tend to notice that the distribution of procurement
contracts (or jobs in the public sector) is unfairly skewed toward the same
people, those with closer ties to the mayor. This triggers media reports and
spreads information to a wider number of voters, who, on receiving this new
information, update their beliefs over the mayor’s competence and behavior,
and decide whether the level of corruption is indeed too high and should be
punished. When too much corruption becomes visible, mayors have a lower
probability of survival.
Intuitively, there is no justification of why corruption should entail a
linear effect on the probability of winning (so that it is either a strictly
increasing or decreasing function of corruption). It is much more likely that
the relationship depends on a specific situation the incumbent is in. For
example, is the incumbent electorally safe, or does he have to fight for his or
her seat? The effect of corruption on re-election can depend on the
uncertainty surrounding the electoral race. If a politician expects a close
race, he is less likely to engage in corruption (to “loot”) but more likely to
try and disturb the election process to win (to “cheat”).26 In other words, the
behavior of a politician depends on how well he performs on previous
elections and to which extent this allows him to cheat.
To sum up, an elite network type of relationship, which reinforces the
creation of corruption, entails a concave effect on a politician’s re-election
chances. Voters see the creation of public goods and reward the politician
without knowing whether he delivered the public goods with some
corruption. This partially corresponds to political agency models, where
political types (good or bad) are hidden, so voters must infer type based on
action—whether or not the politician provides enough public goods and at
what cost. Public goods can be provided under a high cost by a bad
politician who extracts rents (and still gets re-elected) if the voters believe
he faced a high-cost shock. Extending this logic further, a bad politician can
fool the people only a few times before such practices get uncovered. Hence
the concave effect.

6.4. Case Study: Using Corruption and Minimum Winning C

oalitions to Stay in Power
Why is it important to establish that there is a nonlinear, concave effect
between corruption and probabilities of political re-election? This is the
main mechanism that politicians rely on in order to preserve their position.
They are intuitively aware of an upper limit of suspicious allocations they
are allowed to make, before being uncovered and punished by the voters. In
more developed democracies, this limit is very low, and is inversely related
to the level of accountability. Low accountability and low transparency
environments in highly developed democracies are similar in their levels of
corruption and their impact on re-election to high-corruption, less developed
democracies. In their case, the upper limit of “allowed” corruption can be
quite high.
A good example is the empirical case of Croatia, an EU member state
with particularly high levels of corruption, and a relatively young democracy,
developing in the aftermath of a devastating war in the 1990s. Croatia is
interesting since it provides a case-in-point of both the selectorate theory, in
terms of how politicians build minimum winning coalitions to stay in power,
and the elite network theory, in terms of how both politicians and their
connected firms can benefit from entering into mutually dependent
relationships.
To paint the picture, consider the high-profile cases of corruption
uncovered in the country. The former prime minister (who was in power for
six years) was found guilty on corruption charges for forcing state-owned
companies to give exclusive procurement contracts to a media company, from
which the PM himself, and a few of his close cronies extracted funds
directly. His political party, the conservative HDZ, was also found guilty in
the same process and was ordered to return the illegally acquired funds of
around €4 million, used to finance their campaign. The former PM was
sentenced to nine years in prison, but the country’s Supreme Court brought
down the entire sentence two years later based on a technicality, returning the
process back to the city court.
On a local level, instances of corruption were even worse and have in
many cases gone without major punishment. Mayors from big cities,
originating from the entire spectrum of political parties (right, left, liberals)
were arrested or accused for abuse of power, bribery, and striking favorable
deals with selected private firms. The mayor of Zagreb stands out as an
emblematic case. In power for 20 years, he was arrested, released
immediately after paying the largest ever bail of €2 million, arrested again
for breaking probation by intimidating witnesses, and five months later
released from jail thanks to the quickest ever decision of the Constitutional
court in his favor. He ran the city from jail through his many proxies, and
even managed to depose his deputy, a figurehead temporarily placed in
charge, while still in jail. After his release, and during a series of trials, he
managed to get elected twice as a member of parliament with his new party
(only a few months after being released from jail), and won a new term as
mayor in the 2017 elections (two years after his prison stint). He never lost
an election afterward. He died just before the 2021 election, and was hence
never punished by the voters for any of his transgressions. He is not the only
mayor that did the same. At least two more mayors got out of jail on
corruption charges, and managed to get re-elected with ongoing trials.
There is something particularly problematic in the ability of Croatian
voters to effectively punish their politicians. Many local politicians hold
office for more than 20 years (with the average tenure being 12 years, three
full terms). Even the case of the prime minister was not a punishment enacted
by the voters. The process of his incarceration started only after an internal
party struggle, where he was hoping to pull strings from the shadows. He
was stopped by political power, not by the will of the voters or by the justice
system.
The way political institutions are defined in the country encourages such
outcomes. Local office knows no term limits, mayors have virtually
unchecked decision-making power in their local constituencies (in terms of
urban planning laws or administering procurement contracts), and the
motivation for corruption in general is high. I have therefore used the case of
Croatia to test the first part of the elite network theory: the benefits of staying
in power while engaging in procurement-based corruption, the proxy for elite
network level connections between politicians and connected firms. This
was published in my paper titled “Corruption and Re-Election: How Much
Can Politicians Steal before Getting Punished?”27
The paper made two important contributions that help us understand the
mechanism of the elite network theory. First, it reinforced the idea of
measuring grand-scale corruption directly through fraudulent public
procurement contracts. This is a good proxy of seeking a connection between
firms and office-holders. The procurement contracts database consisted of
over 400 thousand contracts administered on a local level of government, for
556 municipalities over an eight-year period. This database was connected
to firm-level financial statements, thus enabling direct recognition of
suspicious allocations. “Suspicion” is defined precisely, and verified based
on official interviews with people involved directly in the procurement
process (from special police investigators, to national and local government
officials, former mayors, civil society watchdogs, and firms participating in
procurements). The definitions included cases in which firms with no
employees and as a single bidder on the tender received procurement
contracts worth millions, or in which firms signed contracts that vastly
exceeded their capabilities (e.g., miniscule average revenues in the years
before the tender, followed by a multimillion contract from the tender), or
when firms with substantial losses received indirect subsidies through
lucrative deals. Quantifying corrupt behavior this way yields more precise
insights into the actual state of affairs in the political system of a country than
can be done by using survey perception indices. Not to mention that it
provides a direct implication of elite-network-induced corruption.
The second contribution is the confirmation of a causal impact of
corruption on re-election, proven to be a nonlinear relationship. Corrupt
practices entail a concave effect on re-election chances, meaning that
corruption can increase the probability of re-election, however only until a
certain level, after which corruption is too high and a politician gets
punished. By showing this I successfully bridge the gap between two
competing hypotheses of why voters do not punish corruption—they do, but
not until it becomes too large and hence too noticeable. I also find an optimal
level of corruption to keep a politician in power. Probability of re-election is
maximized at about 20% of all funds corruptly allocated from public
procurement. If more than 50% of all procurement is allocated illegally, a
politician very likely loses power (see Figure 6.1). As emphasized earlier,
the level at which Croatian voters tolerate corruption is considerably high.
There is strong reason to believe that similar countries of eastern Europe or
southern Europe, with equal levels of democratic capital or levels of
corruption, would have similarly high levels of tolerance for corruption.28
In order to make a causal implication, ideally, we would need to
randomly assign corruption in similar cities and municipalities and compare
political outcomes with respect to the level of corruption. But achieving a
random allocation is impossible since corruption for each city or
municipality is determined endogenously by the politicians and voters.
Figure 6.1 The predicted concave relationship between corruption (measured as a composite index of
the different measures of suspicious procurements) and the chances of re-election. Probability of re-
election is maximized at around 20% of total procurement corruption (20% of all contracts allocated
suspiciously). Source: Vuković (2020).

A way around it is to use quasi-experimental designs where we can

assume randomness over the observed outcome. In this particular case I
exploit the fact that local government law defines a fixed number of city or
municipality council members based on prespecified population thresholds.
As the population size of a city or municipality increases, the number of
council members increases automatically by two to four. The smallest
municipality with up to 500 inhabitants has 7 council members, the next
threshold is 1,000 inhabitants with 9 members, the next threshold is 2,500
with 11 members, and so on. This is an exogenously imposed rule (local
mayors cannot affect it, nor do they have a particular incentive to increase
population size to bring on more council members) which makes it as good
as random over the observed outcome. We can then compare cities and
municipalities with similar size around the threshold where the only
difference is the number of local council members. For example, a
municipality with 990 inhabitants will have 7 council members, while a
municipality with 1010 inhabitants will have 9. These two municipalities
are, by assumption, very similar in their fiscal capacity (tax revenues,
expenditures) and several other observable and nonobservable
characteristics. The point is to specifically compare similar cities and
municipalities, based on size, revenues and expenditures, tax rates,
population distribution, location, exposure to war, and so on, where the only
differences are the exogenously imposed number of council members and the
levels of corruption. This brings us close to approximating the experimental
method based on which we can have some say over cause and effect.
Why would the number of council members matter? I find that council size
in each city and municipality is highly correlated to corruption. The logic is
simple: higher city or municipal size implies higher budgets, which increases
the volume and opportunities for suspicious procurements. Very small
municipalities have very low budgets and low opportunities to embezzle
large funds. Larger cities have a much greater scope for corruption.
Furthermore, uncovered cases of local corruption in Croatia are very often
linked to mayors buying support from council members to get a majority in
the local council, typically through nepotism or by handing them procurement
contracts with the city. The pure size of council members is therefore a good
instrumental variable (IV) to use in order to measure how procurement
corruption affects electoral outcomes.
Figure 6.2 The concave implication is also dependent on city/municipal size. In very similar smaller and
midsized cities and municipalities corruption is higher for units just above the population threshold
compared to those just below the population threshold. For big cities the opposite is true. The dotted
lines denote the six population thresholds defined by law. Each dot represents average corruption for
cities or municipalities just above or just below the population threshold (within ±5% population size).
Source: Vuković (2020).

When comparing two cities with the same population size and roughly the
same budget there should no big difference in procurement corruption, unless
it is indirectly induced through buying votes of local council members. To
uncover this, I only compare cities and municipalities close to each
population threshold (see Figure 6.2), where the relative difference in
council size is much bigger than the difference in population size. Notice that
the concave relationship is also confirmed with respect to city and municipal
size. In smaller and midsized cities and municipalities corruption is higher
for units just above the population threshold compared to those just below
the threshold.
Therefore, a local mayor in a city just above a population threshold that
allocates him two more members in the council, in order to stay in power,
has to broaden his coalition by marginally increasing his level of corruption.
As city size increases, you do not need to corrupt as many additional council
members. The reason is that in smaller municipalities two additional
members mean a lot in relative terms. In big cities with 30 or 50 members,
two additional members are less important for keeping a governing majority.
In each case, we can see that mayors certainly do achieve significant benefits
when allocating suspicious procurement contracts to their loyal winning
coalition members, or in other words, to their elite network.

6.4.1. The Impact of Minimum Winning Coalitions

The final implication is related to the relationship between corruption,
longevity in office, and the impact of minimum winning coalitions. An
extension to the aforementioned findings is a paper looking at local winning
coalitions in Croatia.29 The W/S ratio, measuring relative winning coalition
size, is approximated by looking at the absolute number of votes the winner
gained in each race divided by the total number of eligible voters. The
average W/S ratio in this case was 27%, meaning that for an average city or
municipality, a politician wins elections if he gets only 27% of the total
eligible electorate to vote for him. This is not surprising given that turnout for
local elections is typically very low, between 40% and 50%. It also means
that local politicians in Croatia need to get only a small number of people in
their winning coalition to stay in power. For example, for an average small
city of 3,000 inhabitants, where 2,000 people have the right to vote, and
turnout is only 40%, a politician needs 400 votes to win. This is not a
difficult task to achieve. It is easy to see how local level minimum winning
coalitions are able to keep politicians in power for long periods of time.
Overall, a higher W/S ratio—more people needed to win an election—is
shown to decrease total tenure in office. Across three terms in office, a
politician in a low W/S ratio city or municipality is likely to have one full
term in office more than a politician in a high W/S ratio city or municipality
(12 years instead of 8 years). Interestingly, this is highly correlated with
corruption, as the same areas with a low W/S ratio, where politicians are in
office for a longer period of time, also have higher levels of local corruption,
approximated again through suspicious procurements.
Finally, small coalition environments are also shown to have higher local
tax rates, and the magnitude of the effect is quite large (Figure 6.3). Moving
from a high W/S ratio unit to a low W/S ratio unit, local tax rates are 30%
higher (around 1.5 percentage points, which is a large effect given that the
average local tax rate is 4%). Interestingly, tax rates are also highly
correlated to levels of corruption, arguably through the W/S ratio. Moving
from a low corruption to a high corruption unit increases local tax rates by 2
points, or around 50%.
Figure 6.3 Negative correlations between the W/S ratio and corruption (upper panel) and tax rates
(lower panel).

These findings are striking and suggest a particularly problematic

environment where political longevity in office is closely tied to having a
small but powerful winning coalition, where corruption in the form of
procurement contracts allocated to satisfy the coalition is high, as are the
local tax rates to finance excess spending. This has vast implications for
fiscal profligacy of corrupt governments—greater corruption is used as an
effective mechanism of satisfying loyal elite networks in order to stay in
office longer. Just as the predictions of the political agency literature imply,
politicians can extract rents while maximizing their probability of staying in
power. The missing mechanism explaining this effect is the impact of elite
networks.
⋆⋆⋆
Even though the empirical results presented in this section are mostly limited
to the case of Croatia, the logic of political survival applied here is hardly
different in countries or local regions where accountability is low and
corruption is high. The incentives for politicians to engage with elite
networks in order to build their coalitions are similar throughout, however
the difference between successful and unsuccessful democracies is in the
institutions that either prevent or encourage corrupt behavior. When rules are
clear and enforceable, when the judicial system is not politically captured,
power-hungry individuals can be prevented from misusing political office to
deliver benefits to their elite networks. Countries that lack or are unable to
enforce such rules, or whose institutions are completely or partially captured
by political elites, are unable to break away from the system of elite network
dominance. The failure of a country to limit the power of its elite networks,
both political and corporate, is the first step toward social disintegration that
eventually releases the forces of wealth concentration. The failure is
therefore entirely political. The remedy is to reduce political power.
Before developing that argument in the final section, the next chapter
looks at the second part of elite networks—firms, and how they benefit from
being in close contact with in-office politicians. This chapter has shown their
benefit being manifested only through procurement deals. But firms can
benefit in many more ways.
 7
The Role of the Firm

The difficulties of many European countries derive from their corporatism: state projects serving
cronies and vast social protection programs, both run by elites. These surged in the 1970s and
1980s.
—Edmund Phelps

In this quote the Nobel prize–winning economist Edmund Phelps painted an

accurate picture of what went wrong with most European societies in the
final decades of the 20th century—too much corporatism serving crony and
elite network interests. In his book Mass Flourishing, he lauds economic
dynamism that delivered the greatest progress in human history via rapid
innovations occurring in the aftermath of the Industrial Revolution (the topic
of the next chapter). Corporatism of the late 20th century was recognized as
the biggest constraint to that dynamism and, by extension, the key cause of
rising inequality over the past 30 to 40 years.1
Corporatism, in the classical sense, advocates that a society should be
organized and managed through various corporate groups—business, labor,
military, academic—protecting their interests and competing for government
favors. It is based on the idea of having a strong centralized government that
successfully balances between various competing interests of different
corporate groups and hence carefully manages economic progress. There are
many variants of corporatism but the one Phelps had in mind—the one that
acts as a negation of dynamic innovation—is corporatism in which
corporations and societies demand too much from governments, which
consequentially stifles and overburdens the system with excessive regulation
that benefits the well-organized corporate groups. This is somewhat similar
to Olson’s argument from The Rise and Decline of Nations, in which
excessive pressures of privileged interest groups constrain economic growth.
 Phelps argues that the loss of dynamism in our economies increased
inequality since it hit lower-income workers disproportionately more than
high-income workers. Innovation, in the sense of developing new products, is
labor-intensive, meaning that a decline in innovation reduces labor-intensive
jobs, which decreases opportunity for the low and middle classes and allows
the continuation of wealth concentration at the top. Furthermore, due to a long
period of low interest rates, the middle classes could no longer significantly
increase their wealth through savings. Investing in equities brings much
greater fortune, which is again disproportionally concentrated among the
already wealthy. Inequality, according to this theory, did not reduce
productivity, as some may argue; it was a decline of productivity due to
corporatism that exacerbated inequality.
Solidarity, security, and stability are cited as typical corporatist values
that require an expanded power of governments to be upheld. They drive the
need for competition-stifling regulation, for interest group state capture,
protectionist industrial policy, special tax laws, and other regulations that
favor narrow corporate interests. Through promoting and sustaining such
corporatist values innovation and dynamism are severely constrained, so
companies resort to rent-seeking practices. Profits of traditional companies
are starting to depend more and more on political protection, while
executives are increasingly guided by short-term thinking revolving around
boosting share prices and capturing bonuses. Achieving political protection
is further rewarded by the boards, which drives the dispersion of incomes at
the very top, as shown in Chapter 4. A potential consequence was a parallel
decline in total factor productivity growth, coupled with record-high levels
of corporate profits as share of GDP, as shown in Figure 7.1.
Figure 7.1 US corporate profits as share of GDP compared with average annual growth rates of total
factor productivity. Source of data: ILOSTAT (2020), and St. Louis Fed, FRED (2021).

Total factor productivity in the United States has been in relative

stagnation ever since the mid-1970s (with the exception of one decade, from
the mid-1990s to the mid-2000s). It was around 2.2% from the 1940s until
the 1970s, and only 0.8% since the 1980s until 2020. Corporate profits on
the other hand surged in the past two decades. They were on average 10% of
GDP in the 2010s, double the amount of the 1980s. Economic theory is clear
on why productivity matters. As new technology is introduced and
innovations adapted, better methods of production increase output for less
work input, thus increasing worker productivity and consequentially
increasing their wages. Technological progress and innovations since the
Industrial Revolution increased societal progress primarily through increases
in productivity. Therefore, we shouldn’t worry about inequality created by
technological progress, as its impact is only temporary. The productivity
bandwagon soon delivers progress and better living standards for all.
While this is true on aggregate and in the long run, Acemoglu and Johnson
argue that this process of translating innovation into higher wages and greater
living standards for all is by no means automatic. New technologies work
and deliver progress only when they increase marginal productivity of
workers. This was very much the trend since the late 19th century, and
especially after World War II. All major technological advances back then
led to increases in productivity, making sure that progress was shared by all
(think of the benefits of electricity or production automation that created new
tasks and many new jobs). However, since the 1980s, the authors argue,
advances in technology were primarily focused on cutting costs, thus
boosting corporate profits, but delivered no real benefits to worker marginal
productivity. In fact, the authors directly blame automation for the decline in
average total factor productivity and consequential rise of inequality of the
past four decades.2 This explains what we see in Figure 7.1, the share of
corporate profits went up due to cost cutting, not better innovations or greater
productivity.
But this is not the full story. As profits no longer depended solely on
achieving disruptive innovation, this created incentives for the rise of rent-
seeking firms. Firms with deep connections to the state are by no means a
historical exception or a creation of the modern age. The powerful
mercantile monopolies like the British East India Company, the South Sea
Company, the French Mississippi Company, or the Dutch East India Company
(VOC) were extensions of their governments in controlling trade links and
colonization of new territories. We saw in Chapter 5 how this was done in
16th-century Spain, where the king directly granted privileges to selected
nobles. Similar processes happened in other empires and kingdoms, but the
political protection of monopoly rights continued until the modern era.
Even today some companies are still justified as natural monopolies,
providing a public good that the market is unable to provide fairly and
efficiently. But outside the scope of natural monopolies, many modern firms
still seek political protection to grow and expand their business. Such rent-
seeking firms are the interest of this chapter. Firms that rely on elite networks
to achieve their benefits from governments. Firms that are privately owned,
but instead of competing on the market for customers, compete for political
support. Specifically, firms whose primary source of income is conditional
not on government contracts, but on political connections to get those
contracts.

7.1. Rent-Seeking vs. Customer-Seeking Firms

Expanding on the findings of Chapters 4 and 5, we can split firms into two
basic types based on their willingness to engage with politics and hence elite
networks: rent-seekers and customer-seekers.3 There are obviously shades of
gray in between them, but to keep things simple any firm whose revenues
predominantly depend on political favors granted via lobbying or friendship
links, and which manage to change regulations or secure a non-market-
generated source of income is defined as a rent-seeker. On the other hand,
any firm whose revenues purely depend on satisfying some market demand,
and does not at all depend on having a political connection in order to
survive, is defined as a customer-seeker.
A customer-seeking firm is not the subject of attention in this book. These
are regular firms that exist to provide an unmet market demand within a
certain niche or territory. The vast majority of micro, small, and medium-
sized businesses, as well as some large firms like major disruptive
innovators, are customer-seeking firms. They typically advocate lower
government regulation and a lower tax burden to help them grow and expand.
However, they are notoriously difficult to organize, and have very little
salience with which to influence policy, which is why they are placed on the
lower left quadrant of Figure 1.3 in Chapter 1. In corrupt countries,
anocracies, and weak democracies, depending on the industry they operate
in, they can be subject to political or criminal extortion (e.g., paying money
for protection). But their underlying principle is not to engage with politics
or seek political favors to increase their revenues.
Rent-seeking firms are diametric opposites of customer-seeking firms.
They seek to find a nonmarket way of capturing a bigger market position, and
enter into elite network relationships to achieve this. They are encouraged by
economic rents they secure. Their revenues can arise from market power, but
their market power has been granted to them by the virtue of political power
(good examples here are monopolies or oligopolies4). In many cases they do
compete for and sell to customers, but their main battleground is the market
for political favors. Political decisions can grant them exclusive privilege to
sell to customers, preventing market access to competitors. There is no
distinction in terms of size, however larger firms in particular industries
(like defense or major construction companies) are more likely to depend on
government decisions and hence more likely to ask for political favors. This
does not imply that all companies in such specific industries are rent-seekers,
only those that actively seek and depend on political protection, usually
through personalized relationships with the decision-makers. Finally, rent-
seeking firms need not organize as a collective and fight for their interests
this way. All it takes is for the executive to befriend a politician and they
enter into an elite network relationship, where they are free to exchange
favors.
They employ CEOs and other executives with deep ties to the political
power-holders, and reward their CEOs for deals they get because of politics.
As the findings of Chapter 4 confirm, such connected executives have higher
salaries than nonconnected ones. Furthermore, firms with politically
connected executives pay higher salaries than firms with nonconnected
executives. This mechanism is directly responsible for increasing earnings of
the top 1% and top 0.1% of income earners, thus contributing to the rise of
inequality.
Despite the fact that there is always a risk for a firm to get uncovered for
shady business practices or for its politician to lose office, firms enter elite
networks to essentially lower risk (as shown by the cost-benefit analysis in C
hapter 5). They seek protection from politics in terms of legal or regulatory
acts, or they seek direct rents from government contracts. From the
perspective of the firm this interaction is economically rational as it involves
trading off low cost (of effort and engagement) for a greater potential return
that involves reduced risk exposure. The acts of lobbying and campaign
spending are completely legal and legitimate ways of influencing government
decision-making. Exchanging personal favors between connected individuals
in positions of power is not necessarily always legal but it is in most cases
legitimate. Using political connections implies that you trade off costs of
engagement for rents. When making the trade-off and securing rents, firms
invertedly increase the dispersion of earnings at the top of the income
distribution.
There is obviously a between-firm difference in both cases. Firms in
certain industries, where governments are the only buyer, have no choice but
to do business with governments. The aforementioned defense industry is one
example, health equipment industry is another (in countries where health care
is mostly public). Yet, there is a particular distinction between firms that win
tenders in a fair and open process, thanks to their competitive advantage or
state-of-the-art products, and firms that use political connections to affect the
outcome of public tenders. Corrupt countries with weak democratic
institutions are particularly sensitive to the latter. That being said, even the
most developed democracies are not immune to having powerful
corporations organize cartels, affect legislation, or use political connections
to win procurement contracts. Some of these companies can even be market
leaders with top quality products, yet they still resort to rent-seeking to
preserve their position. This keeps their shareholders happy who, in turn,
reward the politically connected CEOs for providing decent returns.
One possible explanation is that the propensity toward rent-seeking is
contingent on the stage of the company’s life cycle. An innovative customer-
seeking firm, in its early stages of development, when seeking to establish a
niche market position, hardly engages with politics and hopes to attract
customers with a unique selling point. Some may receive seed or venture
capital funding that helps them position in the market and prepare them for
the growth stage. Once reaching growth stage, they are entirely focused on
scaling up their products and reaching as wide as possible a customer base.
During the maturity stage, with sales relatively consistent and linear, the
focus is on reducing costs to prop up profits, but some firms may find it
profitable to turn to executives with political connections in order to
preserve their market leader position from competitors.
A good example here are the US Big Tech companies. Initially all these
companies were major disruptors of their industries, expanding vastly and
exponentially, creating huge value added for consumers. However, during the
2010s, as they reached a certain size, they have increasingly started to hire
former politicians,5 presumably to preserve their status but also to influence
regulatory policy. Political appointments alone do not necessarily make them
rent-seekers, but as the demand to regulate Big Tech increases, the lobbying
activities of these companies will surely increase as well.6 Having former
politicians on their Boards or at executive positions is certainly expected to
help them in curtailing new regulations to their benefit. Therefore, even the
disruptive customer-seeking companies may eventually turn into rent-seekers
in order to preserve their dominant position on the market.

7.2. How Firms Benefit from Collusion with Politics

Now that we have differentiated between two basic types of firms, we need
to turn to the theoretical and empirical findings that explain the motivation of
firms to engage in deep connections with politics.
 The seminal theoretical contributions explaining the link between firms
and politicians come from the economic theory of regulation. George
Stigler’s initial contribution, resting on Olson’s logic of collective action,
was a demand-side explanation showing the effect of cartelization: large,
well-organized firms (led by small, homogeneous groups) will lobby most
effectively and get the benefit of favorable regulation, which will always
come at the expense of consumers (large, dispersed groups which are unable
to organize).7 Sam Peltzman expanded that model to include the role of
legislators who are decision-making agents that seek to remain in power, and
will guide their decisions to fulfill that goal. The electoral concerns of
legislators should explain why big businesses can sometimes be punished, or
why protectionism can sometimes be relaxed.8 Gary Becker then expands
Peltzman’s model by introducing competition between interest groups where
size and within-group free riding determine success in receiving government
transfers.9
A more precise definition of these activities is encapsulated by Tullock’s
and Krueger’s concepts of rent-seeking:10 the process of gaining private
benefits for firms by misusing the political process (via lobbying, campaign
spending, personal connections, or even bribes to influence legislators).
Rent-seeking is usually linked to gaining protection for a particular firm or
industry, which can vary from achieving monopoly status, to barriers to entry
for newcomers that reduce competition (e.g., via licensing or patents), to
imposing tariffs on foreign goods to protect domestic incumbents, or picking
winners via government subsidies. In each case rent-seeking activities
hamper market outcomes by reducing its allocative efficiency and end up
destroying wealth. In the context of this book, rent-seeking is the crucial
ingredient linking collusion between firms and politicians to the negative
consequences of that collusion. In the previous chapter I expanded the rent-
seeking definition to a broader concept of rent-extraction, in alignment with
the political agency literature, to include political benefits of collusion. But
the classic concept of rent-seeking has always been focused on benefits
gained by firms.
Following these seminal theoretical contributions, the next step is to
explain what exactly the interaction between firms and politicians looks like
and, more importantly, what its social welfare implications would be. An
interesting concept that expanded on the economic regulation and rent-
seeking literature was McChesney’s “money for nothing’ ” model of political
extortion. According to this model firms and interest groups that employ
lobbyists pay money to prevent legislative outcomes that could hurt them.
The “money for nothing” paradigm implies paying the price of political
extortion. Politicians propose legislation and regulations that would hurt a
given industry, which is then forced to pay the rent in order for a politician to
withdraw this piece of legislation.11 McChesney argues that many regulatory
wealth-reducing threats are only announced for this particular purpose—to
extract rents from private sector firms. He shows this empirically for the
United States and calls on empirical evidence of a similar rent-extraction
practice in Canada.12
In similar fashion, Shleifer and Vishny describe a clear-cut set of
grabbing hand government models that encapsulate the full benefits of an elite
network relationship: each agent pursues their own objectives, none of which
promote the public’s interest. Their analysis is particularly suitable to
explain the negative social outcomes following dubious privatization
schemes in postcommunist countries. Politicians privatize profitable public
firms by giving them to their cronies in return for continued bribes. They
keep less profitable public firms in the government’s hands and continue to
demand the pursuit of political goals from these firms in exchange for
subsidies.13
Whenever loyal political support is conditioned on various material and
nonmaterial benefits the political system is likely to deliver subpar
outcomes, as the benefits tend to favor the interest of the few (usually the
elite) over those of the many. In his seminal 1982 book The Rise and Decline
of Nations, Mancur Olson warned of the negative implications of the rising
power of cartels and lobbies over time. Their actions, fully legitimate
outcomes of the democratic process, have resulted in the rising power of
lobbyists, lawyers, and bureaucrats who exercise control over the
redistributive flow of resources. As the struggles for redistribution and
favorable regulation between interest groups surpass those of the productive
sectors of the economy, economic growth becomes undermined and decline
is imminent.14
These sets of theories present an accurate depiction of how the elite
network mechanism works, and it clearly recognizes a negative effect of
collusion between politicians and firms on social welfare. What are the
empirical implications? And what is the size of distortion generated by such
networks?
 Empirical research has mostly been focused on confirming Stigler and
Peltzman’s contributions. For example, Bellettini, Ceroni, and Prarolo use a
panel of 62 countries and find that the negative impact of political longevity
on economic growth can be explained through the actions of politically
connected firms that use their power to mitigate regulatory costs, prevent
entry of higher quality competitors, and preserve their market dominance.15
Fisman shows, on the case of Suharto’s Indonesia, that a large part of a
connected firm’s value can be explained by its political connections. He
finds that 30% of Indonesia’s GDP depended on politically connected firms.1
6 Faccio, using a panel of 47 countries, also confirmed that greater political
connections increase firm value. She finds that connected firms (firms with a
large shareholder either in office or connected to the ruling party) represent
almost 8% of the world’s market capitalization. Not surprisingly, connected
firms are more common in countries with greater corruption and lower levels
of transparency (e.g., in Russia they amounted to 87% of all market
capitalization during the 1990s).17
A similar finding is confirmed in the United States, where announcements
of politically connected individuals in the board of directors resulted in
abnormal market returns.18 Conservative MPs in the United Kingdom benefit
personally from industry connections after their time in office, being awarded
by lucrative positions on company boards.19 Two other papers make the
same inference but for the opposite effect of when the political connection is
lost (i.e., when a politician exits politics, either through retirement or death).
When this happens, both connected firms and connected lobbyists are faced
with losses.20 Furthermore, on a group of 35 countries, it has been confirmed
that politically connected firms tend to receive more government bailouts
during times of crisis than nonconnected firms, that government-owned banks
increase lending in election years to help party-affiliated borrowers, and that
politically connected firms get better loan deals from public banks.21 In
China, examining the impact of political connections on corporate
performance of China’s newly privatized firms, where a quarter of appointed
CEOs were government bureaucrats, the authors find that firms with
politically connected CEOs underperformed the unconnected ones in terms of
post–IPO market valuation, earnings, and sales growth. However, such firms
are more likely to appoint other bureaucrats to the board, which might be the
reason for derailed business performance.22
 Institutions can matter as well. In has been shown in the case of Russia
that weak institutional environments serve to promote partial interests of
firms, and that in environments which fail to demand political accountability
businessmen themselves run for office to reduce their lobbying costs and
directly promote policies that favor their interests.23 A similar finding is
confirmed on the case of the Ukrainian Orange Revolution. Political
turnovers exercise a significant impact on politically connected firms in
weak institutional environments.24 A comprehensive study of political-
business networks in the cases of Poland, Bulgaria, and Romania shows that
the impact of such networks on the formation of postcommunist institutions
was critical to the success of a country’s path through transition. The key
implication is that broad networks in combination with greater political
competition and hence greater political uncertainty generate better
institutions. Narrow networks of elite interests will, on the other hand, result
in weak institutions and worse economic outcomes.25
Firms can therefore clearly benefit from being in close proximity to
politics, regardless of which country or institutional setting we are looking
at. The next step is to again look within firms and how their powerful
executives can benefit even more.

7.3. The Revolving Door between Politics and Finance

Who you know can be much more important than what you know when the
system revolves around elite network superhubs. This has been empirically
proven on a number of occasions. Lobbyists tend to follow their politicians
when they move to different committees, while the impact of a politician
leaving office has resulted in a 24% decline of revenues for a lobbyist
connected to this politician.26 Another study has shown that the US Securities
and Exchange Commission (SEC), the key regulatory body behind securities
fraud, is less likely to prosecute politically connected firms, and even if they
do, such firms will face lower fines.27 Political donations are particularly
helpful here, especially if being given to politicians in the SEC oversight
committees or those in executive government. The SEC is therefore more
likely to punish firms without the backing of politics. This is a woeful
practice that practically legalizes corruption. You are allowed to cheat as
long as you have close ties to those in power.
 As shown in the network graphs in Chapter 1, finance is particularly
prone to being closely connected with politics and thus exploit its close ties
to power. Politically connected firms engaging in securities fraud that the
SEC is not punishing are, in most cases, in the finance industry. Bear in mind
that financial corporations also own considerable parts of other
corporations, both domestically and worldwide. A network analysis study in
2011 has shown that a handful of financial institutions dominate shareholding
positions in most other firms, thus potentially exacerbating systemic risk for
the global economy. In total, 737 top corporate shareholders hold 80% of
ownership control over all other international corporations, while the core, a
very densely clustered group of only 147 firms, three-quarters of which are
financial institutions, holds 40% of ownership control. The authors refer to
them as “super-entities in the global network of connections.”28 One of the
biggest corporate owners in the world is Larry Fink’s BlackRock, giving him
immense elite networking power (see his network in Figure 1.8 in Chapter
1).
At the helm of such “super-entities” are financial sector CEO superhubs,
typically the most connected nodes in the corporate world, exhibiting high
levels of betweenness centrality and maintaining strong friendship links with
politicians in power.29 Money and favors are exchanged frequently, but are
uncovered only occasionally. One practice that can verify their close ties is
the revolving door between the two industries.
The process starts with regulatory and cultural capture, where the
regulators of the industry start adopting the same position of the industry they
regulate, and are themselves often on a lookout for jobs in that industry.
Nowhere is this more evident than between the finance industry and its
regulators. The very process of deregulation in finance that increased
excessive risk-taking before the 2008 financial crisis, in terms of relaxed
capital requirements for example, was driven in part by the process of
cultural capture.30
What starts as cultural capture tends to evolve either into an employment
position within the industry or, during a politician’s mandate, into an elite
network relationship, depending obviously on the position of power of the
captured individual. The cultural capture of people in frequent contact
influences the way of thinking in both directions. More importantly, their
clustering develops personal relationships that are often called on when
problems need to be solved. At that point it is no longer a case of cultural
capture, lobbying, or persuasion by the industry over the regulators. It is a
friendship relationship, where important decisions are exchanged as favors
between friends. This is obviously a normal human condition; we will
always treat our friends more favorably. However, when the stakes are high,
objectivity is what’s valued. Achieving such objectivity in positions of high
power becomes difficult when the outcome of a decision could burden a
friend or frequent associate.
Even so, it is impossible to prevent politicians and corporate executives
from networking, making friendships, and entering each other’s career paths.
This seems to be an inevitable trend in high positions of power. Politicians
from all levels, from high executive office to parliamentary committees with
direct supervision over the financial sector, very often end up working in
finance after their careers. A few high-profile examples stand out. Larry
Summers worked in academia and at the World Bank before entering the
Clinton administration, eventually becoming treasury secretary succeeding
his mentor Robert Rubin, himself a career investment banker from Goldman
Sachs. Before rejoining public service in the Obama administration, he held
a job at a hedge fund, D.E. Shaw, and had various advisor roles at a number
of Wall Street firms. Timothy Geithner was in public service most of his
career, however after being the chairman of the New York Fed, followed by
treasury secretary under President Obama, he ended up as president and
managing director of a private equity firm Warburg Pincus. Jack Lew went in
and out between politics and the corporate world. Lawyer by training, he
started working for congressmen in the House, then went to a private legal
practice, and came back to serve in the Clinton administration. Before
joining the Obama administration first as deputy secretary of state, and in
Obama’s second term as the treasury secretary, he was the COO of Citigroup.
Peter Orszag, serving in both the Clinton and the Obama administrations, got
a job at Citigroup, and later at a financial advisory firm, Lazard. William
Daley, also serving in both of these administrations, had a job at JP Morgan
in between.
The revolving door also counts outgoing appointments. Goldman Sachs
pushed Robert Rubin, Henry Paulson, and Steve Mnuchin to become treasury
secretaries under three different presidents: the Clinton administration, the
Bush administration, and the Trump administration. All three came from top
executive positions at Goldman, with Paulson being the CEO for six years
before taking the position. Goldman is famous for having their employees
take on central roles in government, even more important than treasury
secretary. Their list of alumni in leading government positions include
Australia’s Prime Minister Malcom Turnbull, former president of the ECB
and later Italian prime minister Mario Draghi, and two former technocratic
prime ministers, Lucas Papademos in Greece and Mario Monti in Italy. The
list of other, lower-level government positions, is even larger.
The revolving door works equally well for central bank governors. The
former governor of the Bank of England, Mervyn King, much to everyone’s
surprise given his frequent criticism of the banking industry, became a senior
advisor at Citigroup. King’s successor Mark Carney worked in Goldman
Sachs for 13 years before first becoming the governor of the Bank of Canada,
and then taking over the Bank of England. The long serving US Fed Chairman
Alan Greenspan took various advisory roles on Wall Street after his term
ended. Ben Bernanke, his successor, took advisory positions at the market
maker firm Citadel and investment company Pimco. These are just the most
famous and easily traceable cases. Many more people in every country move
regularly in between the industry and public service. And it is certainly not
limited to finance, with Big Tech also entering the arena as their fates are
becoming more dependent on political decisions.
None of this is illegal or illegitimate. It isn’t even unethical. It makes
sense to hire people with deep industry experience to a delicate task such as
the treasury secretary or central bank governor. It also makes sense that these
individuals want to cash in their vast knowledge, experience, and networking
gained from being in the position of political power. After all, which firm
wouldn’t want to have a superhub with all their powerful connections as
their advisor or on their board? The problem with this practice, which can
never be forbidden or broken up, is that former (or future) top industry
executives are highly unlikely to significantly constrain the power of
industrial giants, nor are they necessarily in the best position to recognize the
difference between what is in the public interest and what is in the private
interest. They are necessarily biased simply due to the close proximity of the
people they have to regulate.
Consider a few examples that showcase how proximity to either
corporate or political power affects decisions. During the heyday of the
financial crisis in September and October 2008, while the Troubled Asset
Relief Program (TARP) was being drafted and conceived, all chief
executives of the eight biggest banks in the country held regular formal and
informal meetings and exchanged daily phone calls with New York Fed
Chairman Timothy Geithner and Treasury Secretary Henry Paulson.31 These
meetings and calls suggested deep personal connections of the bank CEOs to
Geithner and Paulson, both of whom were heavily criticized at the time for
being Wall Street insiders. The deal that struck a nerve, albeit not until
March 2009 when it was uncovered, was the fact that AIG paid $12.9bn to
Goldman Sachs (in addition to a few other big banks) with the money it got
for its own bailout.32
Geithner and Paulson, along with Fed Chairman Ben Bernanke were the
key decision-makers on all policies that were implemented during the
financial crisis, including the bank bailouts.33 They did not make any
individual-level allocation decisions over the distribution of the bailouts, but
they created the process that would serve the interest of their network at the
helm of the banks. The very idea behind the TARP was drafted alongside the
big bank executives, which was necessary due to the severity of the crisis.
The big banks later claimed they were forced to participate in the TARP to
send a positive signal to the economy and complained about the stigma
attached to them for participating. However, during the height of the panic in
September and October, every single big bank was afraid it might repeat the
Lehman or Bear Stearns scenario, and was in high demand for government
help. I confirm this in my own research,34 based on a number of interviews
conducted with legislators and regulators included in the process. Big banks
were not forced to participate. The TARP was by their own design, agreed
within their elite network with top government officials in charge of the
rescue. The big banks did not engage in illicit or illegitimate activities during
this process, they were merely offering advice and complaining to their
friends in high office about their dire situation. Naturally the office-holders
reacted with a sweeping policy.
Such personal relationships forged between the industry giants and its key
regulators can perhaps best be explained by the social connections during a
crisis hypothesis.35 According to this theory every person in a position of
power has a narrow social network of friends whose opinion they rely on
when making decisions. An interesting empirical test of this hypothesis
concerns, coincidentally, the appointment of Timothy Geithner as Obama’s
treasury secretary. When he was announced to be the president-elect’s
nominee, all firms that were connected to him, either through frequent official
meetings or belonging to the same nonprofit boards or business groups,
gained an abnormal return on the markets on the first few days of trading after
the announcement. Then, when news broke out that Geithner might not get the
position due to issues over his tax returns, the same connected firms realized
negative abnormal returns on the markets. These abnormal effects are
explained via the social connections in a crisis hypothesis, given that
Geithner’s appointment was important for a lot of banks in the midst of the
crisis. Quick decisions were necessary and having someone you can trust in
the new administration is certainly reason for optimism.
It is not unusual to observe such outcomes during times of crisis. Research
has found that rent-seeking activities are likely to increase during episodes of
great economic distress given that governments tend to increase discretionary
spending and media oversight is lower.36 A good example here is the British
government’s allocation of procurement contracts to politically connected
firms during the COVID pandemic, uncovered by New York Times
journalists.37 They found that firms that were politically close to the
governing Conservative party, but without much prior experience or even
with prior controversies, received $11bn worth of procurement contracts for
protective equipment, COVID tests, and ventilators. Half of that amount went
to companies that employed former Conservative ministers or gave donations
to the party. The decisions needed to be made quickly, bypassing standard
procedure, given that the stakes were high (battle with the pandemic).
Politically connected firms benefited in this episode of distress simply due to
their proximity to political power.

7.4. Case Study: Political Allocation of TARP Funds during 2

008 and 2009
Proximity to political power is clearly important for firms. It is often enough
to be in the same network of friends to trigger a decision in the firm’s favor,
particularly in times of economic distress. To see this on another intriguing
case study, we must once again return to the 2008–2009 US financial crisis.
As emphasized earlier, efforts to find a solution to the liquidity and
solvency crisis of the US banking system were initially made within a small
elite network of big bank CEOs and the three office-holders in charge of the
crisis. There was no explicit collusion in this case, just a sign that the key
decision was made within a group of friends and close acquaintances in
positions of power. When this deal was made it created a positive externality
for many smaller financial institutions down the line who then used their own
political connections to get a better part of the bargain. Lower-level elite
networks were activated by individual banks to gain a short-run advantage
over the competition in the form of a one-off government stimulus. This is
where the interindustry competition for the allocation of bailouts started. The
stage was set for massive campaign spending and lobbying by an
unprecedented number of financial institutions to ensure that each would get
their own piece of the pie.
This was the motivation for my paper on the impact of political
connections on bailouts given to the finance industry during the crisis.38 The
financial crisis offers a particularly good setting for testing the elite
networking hypothesis, for two main reasons. First, it was an unprecedented
event, where major financial institutions found themselves in the midst of a
huge panic in September 2008, many of which worried about their liquidity
and even survival (particularly after the fall of Lehman Brothers). This made
them desperate for government bailouts and refinancing, meaning that the
event provided good motivation for executives to call in favors from their
friends in politics, or to increase their campaign donations and lobbying
efforts.39
Second, in the midst of the panic and TARP drafts there was an election
campaign for the 111th Congress and the 44th president. Elections enable the
utilization of close electoral races for individual congressmen within a
quasi-experimental design. Comparing politicians in very close races (within
±1% of the 50% electoral threshold) means that outcomes of such races are
as-good-as randomly assigned, given that such candidates are considered
similar in ability and all other unobservable factors, and that the outcome
might have been affected by a factor of pure chance (for example, rain on
election day). As-if random assignment in this case is the closest we can
come to estimating a causal effect (since we cannot randomly assign firms
into political connections), at least for bailout recipients that were connected
to close electoral winners or losers. The point is to see whether a political
connection delivered a better bailout deal to firms that were connected to
narrow electoral winners as opposed to those connected to narrow electoral
losers.
This means we need a good way to measure potential political
connections. I do it in three ways: by estimating abnormal lobbying spending4
0 during 2008 and 2009 for each firm, campaign spending during the 2008
cycle, and most importantly, direct connections between senior bank
executives and Congressmen, using the same database of political and
corporate connections as in Chapter 4. Direct connections assessed whether
Congressmen and bank executives used to work together at least five years
prior to the crisis, or whether they belonged to the same social networks
(clubs, alumni organizations, etc.). The given three ways of measurement
were compiled into a single indicator variable of political connections.

Figure 7.2 The distribution of the logarithm of received bailouts for two subsamples, politically
unconnected firms on the left, and politically connected firms on the right. The red dot denotes the mean
values, while the gray area represents 95% of all observations.

When separating bailout recipients into politically connected and

unconnected, there was a clear indication that politically connected firms got
a better bailout deal, as shown in Figure 7.2. This, by itself, does not carry
any causal implication that politically connected firms indeed got higher
bailouts, given that we do not know anything about other firm-specific
characteristics that could have driven the allocation of bailouts.41 In order to
make these comparisons more realistic and draw causal inference from them,
I applied the aforementioned quasi-experimental design of comparing firms
connected to politicians in close races.
I used four different methods to show the impact of political connections
on the relative distribution of TARP funds. The OLS and matching estimators,
both asymptotically similar, used firms as units of analysis and compared
bailout packages between connected and unconnected firms. They showcase
the same thing as the correlation in Figure 7.2: the effect of a TARP recipient
being politically connected on the size of its received bailout funds.
A more advanced regression discontinuity design (RDD) analysis, which
depends on the as-if random assignment of firms to politicians in close races,
only focused on the subsample of connected firms to generate the firm-
politician unit of observation. It estimates whether a close electoral victory
of a connected politician, within a 1% margin, increased the relative bailout
allocation for the politician’s connected firm. It measures the effect of an
additional politician winning a close election, holding constant all other
politicians’ performance connected to the same firm.
The fourth is the instrumental variable (IV) analysis, which slightly alters
the relationship and instead of looking at an individual politician’s electoral
performance across each connected firm, it measures the total number of
politicians connected to each firm who won or lost a close election. The
effect is the impact of having one additional connected politician, who won a
close election, on the size of bailout received. The results for each estimator
are shown in Figure 7.3, given that each of them has the same dependent
variable: relative size of bailouts.
The first obvious implication is difference in effect size with the selection
on observables approaches and the RDD and IV strategies (OLS and
matching effects shown on left axis, IV and RDD on right axis). This should
not be surprising given that OLS and matching estimate an overall firm-level
effect, while RDD and IV estimate the marginal effect of an additional
connected politician. To make them remotely comparable one should
multiply the individual marginal effect of a connected politician to the total
number of connected politicians for each firm. For example, in the IV sample
the standard deviation of connected politicians who won a close election is
6.8. Moving up by one standard deviation, i.e., donating to seven more
politicians who would win a close election, would increase the firm’s
bailout funds by 47.6%, which is a much larger effect. It is easy to see how
this effect grows stronger for firms that had more connected politicians,
meaning that those at the upper extremes of the distribution will yield the
most benefits from their political connections. The same is true for the RDD
estimation. The OLS and Matching can only give us results for the mean
values of the samples and are hence much less informative.

Figure 7.3 Comparison of different model estimates on the relationship between political connections
and the logarithm of bailouts. The OLS and Matching estimates show a large average effect of around
150% (left axis), but when methods that rely on proving causality are used, comparing in both cases the
results of close electoral races (± 1% of the 50% threshold), the effects are lower but more realistic
(right axis): a close victory of a connected politician increases the log bailout allocation for that
politician’s connected firm by around 4% on average (about 20% higher measured as bailout to total
assets); and, firms with more connected politicians winning close elections received about 7% more
bailout funds for each connected politician (or about 12% more measured as bailouts to total assets).

These joint results suggest that politically connected firms had an

advantage in the bailout allocation when compared to politically unconnected
companies. This does not imply that the decision-makers broke the law, or
explicitly gave more funds to the banks they were connected to, but it does
suggest that it paid off to be part of a congressman’s social network during
turbulent times of the financial crisis. Social connections played a key role in
the political decision-making process, strongly influenced by elite networks.
Such relationships represent a spontaneous survival instinct, which
determines how elite network members react in preserving their privilege or
position of power, an instinct that is particularly strong during times of
economic hardship or episodes of widespread panic. The main take-away
from the case study was summarized in the article’s abstract: “it generally
pays off for firms to be connected to politics, but in times of crisis—it pays
off even more.”42
⋆⋆⋆
What was described in this chapter is a close variant of the corporatism
Phelps was concerned about. Through their collusion with politics, achieved
via personal networking and friendship links, firms are able to gain
considerable rents, both for themselves and for their corporate executives.
This is, after all, the foundation of the economic theory of regulation. The
current literature therefore provides ample evidence on how and why
connections between corporate and political interests form and what
consequences they entail to society.
This book looks at corporate executives and their incentives as just one
part of an elite network. Without pandering to politics, they can hardly
promote their narrow goals. The explanation offered by the economic theory
of regulation and its extension is therefore only half of the motivation to be
included in elite networks.
Elite networking, in the form of revolving doors between public service
and the corporate sector, or relying on powerful friends in times of crisis, or
simply gaining access to privileged information or opportunity due to
proximity to politics, has always existed. It is not a distinctive feature of the
20th century alone. It is a long-lasting force of gradual wealth accumulation
that persistently pushes inequality upward.
As Phelps correctly emphasized, the rise of corporatism in the late 20th
century reduced incentives for economic dynamism that created the vast
progress after the Industrial Revolution. But this was part of a much longer
trend, not a novelty of the 20th century. In Part III, I first show the
unequivocal success of capitalist democracies that took time to deliver the
greatest benefits to societies. Despite this massive success, it failed to solve
the issue of inequality, as it failed to curtail the elite network-driven
persistent force of wealth accumulation. It is important to understand why
capitalist democracies succeeded in delivering progress and how the same
mechanism can be relied on to also solve the issue of wealth concentration
among elite networks. This cannot be done by expanding government powers
as elite networks themselves are part of the government. It has to be done
differently from what we have tried before.
 PART III

REDUCING POLITICAL POWER, THE ROOT CAU

SE OF INEQUALITY

The final part starts with another historical long-term overview, presenting in
Chapter 8 the rise and development of capitalism ever since the Industrial
Revolution. Capitalism was the first economic system that produced constant
incentives for progress in human societies, progress that eventually led to the
origination of democracy. I start by showing how it led to massive,
unprecedented improvements in living standards, but I also acknowledge its
failures, particularly in the early stages, when its critics did raise valid
points. The problem was that the failures typically attributed to capitalism,
like inequality, corporatism, or monopoly power, existed long before
capitalism and are driven by forces that have existed for several millennia in
human societies.
There was something different with capitalism, however. Primarily, it
offered people different incentives. It was within capitalist systems, even in
the early unjust ones characterized by huge levels of inequality and captured
states, where democracy originated. The Industrial Revolution was a
paradigm-shifting event. For the first time ever, people experienced rapid
continued progress, something that modern societies today take for granted.
Innovations were changing the world faster than ever before in human
history. During a single generation people witnessed the incredible power of
the locomotive, the steamboat, the spinning jenny, and the rise of machines
and early factories. The rate of inventions increased exponentially over time,
as did their value to society. It was a signal to the people that the world was
changing, that the Old World was in a decline and a New World was rising.
The Industrial Revolution, through its disruptive innovations, introduced
something that had not existed before—a persistent incentive for change. It
was that incentive for change which inspired major 18th- and 19th-century
revolutions that gave rise to the concept of basic human rights. It was the
incentive for change which delivered equal representation, rule of law,
equality before the law, equality of opportunities, and eventually equality of
gender and race.
All of these changes still failed to solve the issue of inequality, as
presented in Chapter 3, because inequality is driven by different forces. It is
a persistent phenomenon rooted within the misuse of political power. That,
however, does not imply it is an issue that cannot be solved. On the contrary.
In order to solve the problem of unacceptably high inequality, to offer a
solution, we need to focus on the root causes, not the consequences. Standard
proposals like taxation and redistribution, covered in Chapter 9, deal with
the consequences. We need to dig deeper and think about how we can
continue down the path of societal progress to change incentives for the
accumulation of power. This is why an initial brief lesson in history
presented in the next chapter is important to understand how we can move
forward in designing reform.
Chapter 10 presents a set of structural reforms. These are defined through
Three Levers aimed at lowering centralized political power and curbing the
forces of persistent accumulation of wealth and power among elite networks.
This unique set of reforms is arguably only possible to achieve within
developed democratic capitalist systems. A few clarifications are necessary
here. First, the focus is on developed rather than developing countries given
that developing countries typically still have a problem with achieving basic
state capacity to deliver public goods. Once they enter into later stages of
development and achieve a functioning state with arguably higher levels of
inequality (following the Kuznets curve), only then can they move toward
enacting long-term incentive shifts that help curb elite network power and
wealth accumulation. These forces are difficult to curtail while a country is
undergoing rapid development, however they can be controlled through well-
designed institutional mechanisms that build interpersonal trust and social
capital, crucial factors that help maintain functional communities and
societies.
Second, the focus is on democratic capitalist countries, given that
democratic capitalism still provides strong incentives for progressive
change.1 It evolved through many forms and it can still be improved. That,
however, cannot be done via a one-size-fits-all approach or through one
magical policy change. It needs to be done by enacting several simultaneous
reforms that strengthen one another and lock the system in so that it cannot
regress to the previous steady-state. Hence the usage of the term “lever” to
introduce the reforms—what I propose are small yet powerful changes that
deliver indirect incentives to change the system over the long run, thus
helping the democratic trial-and-error process achieve its full potential.
The Three Levers proposed in Chapter 10 provide a fitting conclusion of
the book, as they focus on second- and third-order effects that change
incentives for selection into politics and for entry into elite networks. The
reason elite networks are powerful is due to strong incentives for
membership, as shown in Chapters 1 and 5. We must first think how we can
reduce these incentives, both from a corporate and from a political
perspective. The final chapter is therefore about redistribution. Not
redistribution of incomes, but redistribution of power.
Finally, decentralization and empowering communities hardly makes
sense in societies where the country is already divided between tribal
communities and lacks any central authority to raise revenues and provide
even the basic public goods. These are typically failed or low-capacity
states whose societies are stranded in poverty. For them the goal is first to
reach the next development phase and unleash the spirit of capitalist
democracies before being able to use the democratic trial and error. For
undemocratic countries the initial problem lies elsewhere. They lack the
democratic capital necessary to sustain the benefits of the proposed reforms.
They too first need to unleash the idea of democracy and follow its trial-and-
error process before engaging in reforms aimed at curtailing political and
corporate power. Changing incentives for power and wealth accumulation at
the top is impossible in autocratic or anocratic countries as their very
existence is contingent on a narrow elite network.
 8
Capitalism and Democracy

8.1. How Far Have We Come?

The world today is in a state of constant progress. An unprecedented rise in
living standards across the globe is a testament to this. Life expectancy at
birth globally went up from 46 years in 1950 to 74 years in 2019 (for the
developed world, life expectancy at birth is close to 80 years, up from 62
years in 1950). In every single country life expectancy is much higher today
than at any time in history, with many developing countries doubling life
expectancy over the past half century. Child mortality is less than 1% in the
developed world and down to 3.9% globally, the lowest ever in the history
of mankind, whichever country we look at. The number of people worldwide
that live in extreme poverty (less than $1.90 per day) is also lower than ever,
down to 10% from 40% back in 1980. While the majority of this decrease
can be attributed to China and India lifting a billion people out of poverty in
the past 40 years, even in Africa and across Central and East Asia we are
witnessing a steady decline of people living in extreme poverty and a
significant decrease of the poverty gap (the amount of money a poor
household needs to reach above the poverty line). Obviously correlated with
this are much higher levels of GDP per capita across the globe, especially
among the developed nations. In western Europe GDP per capita increased
from $6,000 in 1950 to $40,000 in 2016. In North America the increase was
from $15,000 to $53,000 during the same period, led by significant increases
of productivity as a result of rapid technological progress. Globally GDP per
capita went from $3,800 in 1950 to $14,500 in 2016, and it is reassuring that
almost every country experienced progress on that front, particularly in the
past 20 years when African countries started growing more robustly (Figure
8.1).1
Figure 8.1 Life expectancy from 1770 to 2019 (panel A), and Life expectancy vs. GDP p/c in 2018
(Panel B), where the size of a circle shows population size for each country. Life expectancy has been
on the rise since the mid-19th century for the developed world, while the developing world started
catching up in the early and mid-20th century. There is a clear positive correlation between Life
expectancy and GDP p/c, and the historical trend points to these two moving up simultaneously ever
since the 19th century. Source of data: Our World in Data, Life Expectancy, Roser et al. (2019).

These global trends have also had an impact on the quality of life,
especially in the developed world. People are working fewer hours (and
have much more time for leisure, which is an important measure of life
quality), consuming more calories with a much more diverse composition of
diets, and there are lower instances of famine and undernourishment than
ever before in the history of mankind (Figure 8.2). One consequence of this is
that people are taller: men went from an average 5’4” (162 cm) in 1896 to
5’7” (171 cm) in 1996, while women grew from an average 4’11” to 5’3”
(150 cm to 159 cm) in the same period worldwide. The rise in Europe and
North America was even greater, from an average 5’5” to 5’10” (165 cm to
177 cm) over a 100-year period.2 Even acts of violence, that persistent
feature of human DNA, have been significantly reduced in developed
capitalist democracies: from an annual rate of 500 murders on 100,000
people in prehistoric times (25% chance of getting killed in a 50-year life
span), to 50 murders on 100,000 people in the Middle Ages (2.5% chance of
getting killed in the same life span), to less than 1 murder on 100,000 people
(less than 0.05% chance of getting killed in the same life span). We are
richer, taller, live longer, eat more and better food, have stopped killing
ourselves as much, and have a richer social life than at any time before in
recorded human history (Figure 8.2).
Figure 8.2 Share of world population living in extreme poverty (1820–2018) (Panel A), Annual working
hours per worker (1870–2017) (Panel B), Homicide rates across western Europe (1300–2020) (Panel
C), and Change in mean male height, 1896–1996 (Panel D). Source of data: Our World in Data: Hasell
et al. (2019) “Poverty”; Herre et al. (2019) “Homicides”; Giattino et al. (2020) “Working Hours”; Roser
et al. (2019) “Human Height.”

With this in mind, the aforementioned issues of dysfunctional democracies

seem miniscule when compared to the level of progress mankind has made
only in the second half of the 20th century. Even inequality, one of the central
issues facing modern societies, seems to be less odious when taking into
account that people are richer and are living better lives. After all, inequality
today is arguably lower than it was before the 20th century when the top 10%
of the population—the kings, the nobles, and the clergy—held 80% to 90%
of all wealth. This was extreme inequality that we no longer observe today,
at least not in developed capitalist democracies. Today, in the most unequal
developed countries the share of wealth of the top 10% of earners does not
pass 50% of total income and 70% of total wealth (with the United States
being the worst example, other developed countries have lower or much
lower shares of income and wealth concentration at the top). This is still high
and certainly problematic, but is on average nowhere near the 90% of wealth
concentration in the hands of the powerful ruling elites, a level of inequality
at the end of the 19th century in Europe and the United States.
The question is still daunting. Why has inequality failed to exhibit the
same long-term trend as declining poverty and rising living standards?
Despite the significant progress we have achieved as a human race, we are
still witnessing levels of inequality which the majority of society perceives
as unjust and simply too high.
Typically, the argument made by critics of capitalism is that capitalism as
a system is prone to massive inequality. But this argument fails on two basic
facts: (1) capitalism is not only present in Anglo-Saxon countries that have
high(er) levels of inequality. It is also present in Scandinavian countries and
across continental western Europe with traditionally much lower levels of
income and wealth inequality than anywhere else in the world (varying
obviously from country to country). Inequality can also be high in socialist
countries, both historically (the Soviet Union and various Eastern European
countries during socialism3) and today. Figure 8.3 compares top 10% of
income share in China, Vietnam, and Venezuela, three countries that are
constitutionally defined as socialist,4 to the United States, the United
Kingdom, and France, three different capitalist countries of which the United
States is a capitalist democracy with the most worrying inequality trends. On
average, inequality is worst in the three socialist countries, where top 10%
share in income is 41% and 42% in China and Vietnam, respectfully, 48% in
Venezuela, while 45% in the United States, 35% in the United Kingdom, and
32% in France. Expanding the sample to include other capitalist and socialist
countries, the inequality numbers do not improve at all for socialist
countries. To be fair, top income inequality in Venezuela has a declining
trend, while China and Vietnam have stabilized their top 10% share of
wealth over the past decade, although still over 40%, larger than in any
European country. Inequality is therefore not contingent on a particular
economic system.
Second (2), inequality, particularly as a consequence of lack of
opportunity for the masses, was higher or as high before capitalism as the
levels of inequality we observe today in capitalist democracies. The long
historical overview in Chapter 2 painted this picture very diligently.
Inequality existed before capitalism and it persists in capitalism. Capitalism
is not its root cause.

Figure 8.3 Top 10% share of pretax income for selected capitalist and socialist countries, 1978–2019.
Source of data: World Inequality Database (WID, 2020), https://wid.world/.

A standard debate between advocates and critics of capitalism usually

revolves around the former citing the great successes we enjoyed as a society
ever since the Industrial Revolution, while the latter typically cite high levels
of inequality, corporatism, and the issue of climate change. These things are,
however, incomparable. Declining poverty and rising living standards are
not driven by the same forces as inequality or corporatism. Poverty and
living standards were affected by the rise of capitalism after the Industrial
Revolution, but we failed to see any rapid improvements until after World
War II when societies started moving toward more inclusive capitalism and
more accountable democratic governance. There is no doubt that capitalism
has brought incredible success in lifting people out of poverty and rising
living standards, being responsible for all of the aforementioned long-run
trends over the past 70 years, sometimes achieved even without democratic
accountability (e.g., China, Singapore). But capitalist democracies could not
solve the inequality issue.
 In fact, this is where the critics of capitalism, Marxists in particular, have
a point. Capitalism in its early post–Industrial Revolution age, in the
beginning of the 19th century, gave impetus to violence power incentives.
The exploitation of workers, even child labor, led to huge levels of
inequality where the masses did not see any improvement in living standards.
On the contrary, they were worse off. Their living standards were terrible;
working in the fields was replaced by working in factories or mines for
longer hours and without any consideration for health and safety. People
were an expendable asset.5 In monetary terms they were still poor, their
purchasing power immensely low, while the elites who held the factors of
production were richer than ever.
The problem, however, was in the distribution over the allocation of
ownership over the means of production. Early capitalism evolved from
mercantilism, where the ruling elites determined the ownership over land
and, consequently, capital. As a matter of historical customs, one could not
own a large company or be granted monopoly rights over exports or imports
of a certain good without having the backing of state power. The relationship
was highly reciprocal, as suggested by the Tammany Hall practice of merging
politics and business into one, cited in the introduction. These were the early
stages of capitalism, all marred with examples of exploitation and
conglomerates growing on state power and proximity of its key actors to the
state. Marx was correct in recognizing the unjustness of the early capitalist
system, but he failed to understand the driving forces behind such a system.
This was nothing new in the wheels of history. This was a powerful force
that adapted to a new paradigm of societal development.
Early capitalism thus treated people no better than feudalism or
mercantilism. The masses were an expendable resource; cheap labor whose
role was to serve the rulers, the nobility, and, in the 19th century, the owners
of capital. Social mobility was extremely low. Opportunity to advance in life
was only possible if a person was part of an elite network. Even the most
intelligent scientist or competent discoverer could not prosper without help
of a wealthy patron. Early capitalism in the 18th and 19th centuries simply
continued the same practices of feudalist times, driven by the most vicious
examples of the violence power principle. This time however, one thing was
different. An incentive to change.
 8.2. Persistent Incentive to Change
The Industrial Revolution changed the paradigm of how people think about
the future. In Malthusian times people were primarily focused on survival, on
achieving subsistence. The Industrial Revolution brought a condition that was
unknown to societies before that—rapid progress, or as economists more
popularly call it—rapid economic growth, the central pillar of capitalism.
This was a time where, within a single generation, people could see the
effects of economic growth unfolding before their very eyes, witnessing
progress like no other generation ever before them. Every single innovation
that came as a consequence of the Industrial Revolution—the steam engine,
the locomotion and the railway system, steamships, machines, chemicals,
cement, gas lighting, and many other innovations that improved everyday life
—all of these were a testament to rapid economic growth. People were
stunned by new innovations. Many saw this era of growth as an opportunity
to achieve life beyond subsistence and advance in the world, a motivation
that did not exist in Malthusian times other than through conquest or elite
network connections.
Furthermore, there was a change in working patterns. As agricultural jobs
were replaced by industry jobs, working conditions changed and societies
adapted. The first consequence was rapid urbanization as people no longer
worked in the fields but needed to be located closer to their workplaces—the
factories in big cities. This led to the rise of the so-called industrial
proletariat, the dawn of the modern-day workforce, but it also signaled a
long switch from the family unit to other forms of social organizations,
including the market and the state.6 There was also the introduction of
universal time in order to define working hours in factories. This may seem
like a minor change, but the concept of tracking time changed the way people
thought about work and how they made their plans. Hence the most important
change: the way people started thinking about the future after witnessing
progress around them. They started thinking about the world they were
leaving for future generations. Economic growth enabled planning for the
future because there was finally a future to look forward to.
This is where money and credit took societies to new highs, and cemented
the basic capitalist model for the ages.7 In Malthusian times the world was a
zero-sum game as there was no consistent economic growth. Societies
certainly did develop, and innovations happened, but development was very
slow, long-term economic growth was miniscule, and the lasting effects of
significant innovations or societal changes were almost never witnessed
within a single generation.
In the preindustrial age, economic incentives were severely constrained.
Getting a loan to start a business was difficult but possible—e.g., merchants
in Italian city-states used loans since the 11th century to finance their
ventures8—however, credit creation was severely constrained due to two
reasons: (1) lack of trust (lat. credo) and no possibility of planning for the
future, and (2) Christian and Muslim religions declaring money lending and
charging interest as usury, limiting it to Jewish lenders who were allowed to
lend money to non-Jews.9 Their capacity to do so on a massive scale was
obviously limited, particularly since the Catholic Church used the usury
allegations to prosecute Jews. Any significant access to finance was
therefore limited to elite network members who were the only ones who
could provide collateral to justify a loan. Common people with good ideas
lacked the means to do that, nor did they have time for creativity and
innovation. They were busy achieving subsistence.
It was a negative feedback loop: the poor majority had a very limited
capacity to access finance in order to change their living standards through
exploring new opportunities and opening businesses. No new businesses and
no new opportunities meant they remained in feudal poverty, having their
already low wages being further depleted through taxation. Rulers and
governments thus had an upper limit on tax revenues, prompting them to
choose a different strategy for enrichment based on the ideas of mercantilism
and conquests of foreign lands: maximizing the intake of gold bullion from
abroad was the most efficient way to increase the size of the pie. Economies
did not grow endogenously through innovation. They grew through conquest
and violence, as did the wealth of the elites.
The Industrial Revolution changed this by opening doors to credit
expansion and the emergence of capitalism. Rapid economic progress and
improving living standards from one generation to the next established trust
in a better future. As more people started planning and saving for a future that
was becoming less uncertain, the newly attained level of trust increased
incentives for credit expansion. Credit was increasingly becoming available
to the rising class of merchants, progressively more so than ever before in
history. It was also, obviously, more available to the nobility and the rulers
who used it to finance wars and new conquests.
 In addition to credit expansion, capitalism brought new virtues, new
ethics of having production being reinvested into more production, ensuring
that the current levels of growth persist. It was a true revolution in business.
Production kept growing on good foundations—products were hitting
markets at more affordable prices and early consumerism was born. As
businesses grew, they hired more people. As they continued to grow, they
paid more money to their employees and hired even more of them. All this
extra money, plus the availability of credit, made the common folk capable of
buying stuff too. Stuff they could never have owned before: houses, vehicles,
better food, better clothes, better appliances. The consumerist mentality
bounded well with the idea of constant growth and the mass availability of
credit. Its end result was an empowered population, first economically and
soon politically.

8.3. The Gradual Shift to Democracy

Thus, we arrive to the most important consequence of the Industrial
Revolution. The shift toward democratization. A political consequence of
constant economic growth, rising incentives to innovate, and major shifts in
patterns of behavior were social upheavals and the many revolutions
throughout the next 200 years. People started demanding representation and
equality. The gradual shift to democracy had commenced.
In England this shift was indeed gradual. It was a 150-year-long transition
driven by ongoing reform and expansion of the franchise on four occasions
(three Reform Acts in the 19th century and the Representation of the Peoples
Act in 1918) to gradually grant more and more people voting rights. The
process started with the Glorious Revolution of 1688, when Parliament was
granted more power than the king, and ended after World War I, with the
extension of the franchise first to all men over the age of 21 and then 10 years
later to all women over the same age. Interestingly, the English Glorious
Revolution is an example of discord within elite networks, an occurrence
that happened often throughout history and was typically a catalyst for social
change. The nobility rebelled against the king, demanding greater constraints
and lesser power from the monarch, and greater representation for
themselves. Their success back then initiated a long process of social
changes that started delivering greater representation to wealthier men during
the 19th century, culminating with universal suffrage in the 20th century.
 In France the changes were more abrupt. After the French Revolution in
1789 and a decade-long power vacuum during which the fabric of society
was radically changed through a series of long-lasting social reforms,
Napoleon continued the legacy through his European conquests. Even after
his resounding defeat the legacy remained. In every territory they conquered,
following the ideals enacted after the Revolution, the French brought massive
institutional changes that were aimed at repealing the old feudalist regime
and set the stage for further expansion of capitalism and, eventually,
democracy. They introduced the Code Civil, abolished guilds, initiated land
reforms, abolished slavery, and emancipated religious minorities (in most
cases the Jews). Even in what was a very short-lived reign they managed to
make drastic changes10 that motivated further revolutions across Europe in
subsequent decades, culminating in the famous Revolutions of 1848, also
known as the Spring of Nations. These revolutions, led by a temporary
coalition between the rising bourgeoisie and the impoverished workers,
simultaneously took place in almost all major European empires of the time:
France, the Netherlands, the Austro-Hungarian Empire, the German
Confederation states, Italian states, Denmark, Belgium, Poland, etc.
Historians describe the 1848 Revolutions as a mixed success at best, but the
stage was set for even greater demands for social change. The world,
however, had to go through two world wars to finally get there.
With the rise of democracies, particularly during the 20th century,
capitalism went through its final transition. From an unjust system that
exploited labor and encouraged violence power incentives that perpetuated
the forces of wealth accumulation, it gradually evolved into a much fairer
system. The impoverished workers first organized into unions and soon after
into political parties to represent their interests. They successfully enacted
labor laws and regulations protecting their rights and banning child labor,
thus irreversibly changing the way owners of capital treated their employees.
Over time people started demanding greater access to education and
information, which increased the role and importance of media in society, not
to mention the rapid development of science and various elements of social
security (health, pension, unemployment), all of which positively affected
economic growth. As the population was getting wealthier, the demand for
all these factors—quality education, health care, information, science—kept
increasing, thus creating a virtuous cycle of development. Citizen
empowerment brought about demands for greater participation in collective
decision-making, thus increasing the legitimacy of governments and rendering
a positive effect on social stability and the growth of democratic capital.
All of these changes happened within evolved capitalist systems.11 It was
possible under democratic capitalism to fight for and achieve greater human
rights. The evolution from Malthusian times of subsistence into modern-day
democratic capitalism had to go through the early stages of injustice and
inequality. The ugly early capitalism was evolving from an odious system to
begin with. It cannot bear the burden of forces that preceded it. But it did
manage to subdue those forces and gradually, over 200 years, ensure that
people live in much richer, fairer, and equal societies.
Obviously, democratic capitalism didn’t solve all problems. Many of
them still persist even in countries with a long-lasting democratic tradition,
as shown repeatedly throughout the book. We criticize democracy as a system
of government so often that we tend to forget the incredible accomplishments
achieved in our quest for democracy and its long-run manifestation. We tend
to forget the fact that capitalist democracies have a tendency to change for the
better. No other economic system in human history had this feature. Often
along the way they may result in suboptimal outcomes and social injustice,
even result in wars and revolutions, but the story ever since the Industrial
Revolution has been one of persistent progress and an attempt to change the
system for the better.

8.4. Democracies as a Trial-and-Error Process

The democratic element in a society carries a strong incentive to change and
improve itself. Although we can often see democracy’s deficits in the short
run—characterized by things like political gridlock, corruption, bureaucratic
inefficiencies, interest group state capture, vote buying, gerrymandering—
over the long run a democracy undergoes persistent trial and error before
arriving at prosperous and just social outcomes.
Democracies have a multitude of hidden strengths, against which an
authoritarian regime ultimately often fails. Democracies, as well as
capitalism itself, strive on the idea of competition. Competition in the form of
selection of different alternatives implies more creative solutions when it
comes to dealing with challenges. Certainly, this sometimes implies poor
judgments being made and dubious outcomes arising as a result, but as the
market system, democracy too relies on trial and error. Thinking of the nature
of our society, we all thrive on this system. It teaches us not to repeat the
same mistakes of the past. A good example is the underlying idea behind the
European project—never again to allow a war on the continent. Thus far the
idea has been quite successful (at least among EU countries12), however even
with such noble ideas it takes time for them to work and prove their
resilience to outside shocks and disturbances.
This is why democracies appear to be more fragile than they actually are
—they are characterized by a complex decision-making process, which need
not always yield the best possible outcomes immediately. Where one can see
a sign of weakness (gridlock, slow responsiveness, negative political
selection), this may just be a short-term response of the system to some
earlier made errors. When too many of these errors pile up, they congest the
system (corruption, cronyism, vote-buying, the sovereign debt crisis) and
signal to the electorate that things need to be changed. It will take time before
the electorate recognizes the correct set of ideas and people to solve the
piled-up errors, but at one point they will succeed in doing so. Or at least,
within a democracy, voters will be given this option. In the process other
errors will surely be made, but due to even closer scrutiny and transparency
from the electorate the process will inevitably end in success. As it did many
times before despite striking opposition and doomsday prophets.
The key to a successful democracy reached by a series of trial-and-error
processes in Western history is to erect institutions that will limit political
power. Democracy mustn’t turn into a tyranny of the majority. This is why
political freedoms are crucial and why institutions that enable transparency
and scrutiny are essential in ensuring a long-run survival of democracy.
Particularly for a country new to the idea. Many new democracies get
preoccupied with elections and fail to design institutions that prevent some of
democracy’s main failures. They fail to establish a good constitutional
system with an emphasis on the rule of law. This is a typical reason for early
failure of democratic consolidation. Their trial-and-error process is arguably
going to be much longer, particularly if new democracies quickly descend
back into authoritarianism. When long-lasting democracies exhibit signs of
failure their trial-and-error process is quicker and such countries will
resolve their structural problems relatively faster, despite the perception of
difficulty to change a congested system.
Which brings us back to the initial point: it is much easier to change a
faulty system when you have the possibility to do so. In a democracy people
have an option to change an unjust and corrupt system, and they often seize
that right. The great victories for liberty during the civil rights movement or
the emancipation of women, both of which signaled an end to a long period
of unfair and unequal societies, testify to this argument. It took more than one
hundred years from Lincoln’s abolition of slavery for the African Americans
in the US South to gain equal rights. In the mean time they suffered great
inequality and almost zero social mobility, not to mention the lack of some
basic human rights. Even today, while certainly better off than in the 1960s,
African Americans still yearn for greater economic equality and feel their
human rights aren’t being respected. All of this is happening in a country that
was supposed to be a prime example of an accomplished and fair democracy.
This simply shows that those periods were times of “error,” and it took a
long time for them to get fixed. Democracy, just like an economy, always
converges toward an optimal equilibrium but is never quite there. It presents
a persistent notion of positive change. Along the way, during the convergence
process, there will always be errors and concerns. Sometimes the trial-and-
error process will seem to last too long, but eventually it always triumphs. It
will make democratic countries look weak, but it is arguably the biggest
advantage democracies have over any other system of governance, which is
precisely why they will always be successful in fixing their problems.

8.5. Socialism’s Rapid Industrialization with a Lack of Trial-a

nd-Error in the Underdeveloped Periphery
Thus far we have only focused on the democratic capacity building in the
countries of the so-called core,13 where capitalism first emerged and
produced the aforementioned incentives for democracies. What about the
underdeveloped periphery where, instead of capitalist democracies,
socialism took root and molded societal development in an entirely different
fashion? In periphery countries, which adapted socialism in the 20th century,
democratization came at a very late stage, after the process of rapid
industrialization and urbanization, not alongside it as in the core countries.
How successful was socialism in delivering the same socioeconomic
outcomes (in terms of the breakout from the Malthusian trap), existing in
parallel with capitalist democracies in the 20th century?
Judging the core and periphery countries by the same standards would be
wrong. During the early onset of capitalism in the core and its political
consequences throughout the 19th century, countries of the periphery were in
a lower stage of development. The economic historian Alexander
Gerschenkron refers to periphery countries as being characterized by
economic backwardness, meaning that such countries go through different
stages of catch-up development than the economically developed countries.
He primarily compares Russia, an example of backwardness, and Britain, the
frontrunner of economic development. He finds that when backward
countries embark on industrialization we witness higher rates of economic
growth, a more active role of the government to stimulate growth, greater
emphasis on capital-intensive rather than labor-intensive production,
importing technology from the more developed economies instead of
innovating to produce their own, and lower living standards during this rapid
process.14
This is similar to the economic theory of convergence. Countries with
lower levels of initial development (lower GDP per capita) grow at much
higher rates in order to catch up to the more developed countries. This is
what happened in almost every peripheral country under socialism: periods
of rapid industrialization and urbanization, very often driven by the state to
promote quick progress, which led to higher initial levels of economic
growth, until the economic model ran out of steam for more structural
reasons, namely lack of innovation to sustain progress.
Countries in the periphery did not therefore experience a gradual shift
from imperialistic mercantilism to a capitalist democracy. Their path was to
move from a mainly agricultural economy with very little industry or
infrastructure, with no colonial exploits to benefit from (many were colonies
themselves), to a phase of rapid industrialization. They never went through
the innovation phase of rapid progress that shifted the mentality of the
population, nor did they gradually offer incentives for common people to
build their fortunes and, over time, demand political change. Their rapid
growth in the 30 post–World War II years (from the 1950s to the 1980s) fast-
tracked 200 years of gradual progress that happened in the core. By the time
the economic model ran out of steam, the empowered population demanded
changes, and the revolutionary wave of the 1980s demanding democracy had
begun. First in Poland, and by the end of the decade in almost every Eastern
European country: Romania, Hungary, Czechoslovakia, East Germany,
Bulgaria, and Yugoslavia, where the breakup was followed by a series of
wars in the newly founded Croatia and Bosnia and Herzegovina. The Soviet
Union reached its own dissolution in 1991, and the era of transition from
socialism to capitalism had officially begun.
Note that this scenario concerns countries of Eastern Europe and the
former Soviet Bloc, the most emblematic examples of socialist development
in the context of a peripheral country. Peripheral countries in other parts of
the world (Africa, Latin America, the Middle East, and parts of Asia) had a
colonial heritage to break out of, where socialism was a particularly
attractive alternative to the imperialism that continuously exploited them.
They thus experienced a different path of development, resulting mostly in
two extreme alternatives: a weak state with no capacity to organize a society,
or an authoritarian state with little incentives for economic progress. Given
that a number of these countries are either nondemocratic or have low state
capacity, and given that a lot of them are still agrarian societies, there is no
final outcome of the transition to which we can make the comparison. I will
therefore limit the rest of the analysis only to Eastern Europe and its path to
capitalist democracies. The closest to their experience were Latin American
countries, particularly with respect to very similar postcommunist economic
outcomes, however given their complex colonial origin and different
historical patterns of development, a better comparison to the Western
European core is the Eastern European periphery.

8.5.1. Condensing 200 Years of Gradual Progress into 30 Years of

Rapid Growth
How did socialism deliver rapid industrialization and what consequences
did this render for the peripheral countries of Eastern Europe? While early
capitalism and early industrialization were in full swing in the 19th-century
European core, the periphery was still mainly an agrarian society, falling
behind rapidly as it managed to elude the innovations of the Industrial
Revolution. The Russian Empire, the Ottoman Empire, and partially even
Spain and the Austro-Hungarian Empire had ruling elites that saw a major
threat from progress of the Industrial Revolution and actively worked on
suppressing it and preventing rapid industrialization.15 With economic
backwardness the countries of the periphery stayed entrapped in monarchist
systems until World War I.
A good proxy for development of those early industrial times is the extent
of the railway network and population size of major cities. The shift from
agriculture into industry significantly expanded the cities. As more factories
were being built, usually around city centers, this attracted more and more
people from the countryside, looking for new industrial and manufacturing
jobs, to live in cities. Hence urbanization always followed industrialization.
The railway network served a dual purpose in this rapid development; it
provided a fast link between the factories in big cities and the country’s
major sea or river ports, and it was an important connection of internal
markets. The people and the economy were moving fast and the railroad
network was their bloodstream.
Figure 8.4 shows that by 1880, Britain, the forefront of industrial
development, had a deep network of railroads, while many peripheral
countries either had no railroads at all or had only a few bigger cities
connected this way. Even among the core countries it is visibly obvious
where development was faster, with France, Germany, Switzerland, and the
Benelux countries following closely behind Britain. The famous Orient
Express, established in 1883 with a goal of connecting Paris to Istanbul
through Vienna, had to use a 14-hour ferry ride from Varna in Bulgaria across
the Black Sea to reach Istanbul. The line was completed in 1889 to go
through Belgrade, although passengers still had to take carriages in parts of
Bulgaria to transfer to other trains before reaching their final destination.
Figure 8.4 The railway network in Europe in 1880, offering a visual representation of the difference
between the most developed societies (Britain, France, Benelux countries, Switzerland, Germany) from
the rest. Note how even the Austro-Hungarian Empire, Spain, and Italy failed to develop the same
infrastructure network by that time, while countries even further on the periphery had almost no railway
links at all. Source: Morillas-Torne (2012).

By 1875 London already had a population of 4.2 million people, Paris

had 2.2 million, and Berlin 1 million. Moscow had 600 thousand and
Istanbul 870 thousand, while the smaller dominions throughout the periphery
had their biggest cities at less than 100 thousand people. It was a clear
lagging behind for the periphery.
It is thus no wonder that the idea of socialism, calling for a new world
order, took root much easier in peripheral economies, entrapped in agrarian
societies and authoritarianism. It failed to develop in countries of the core
even though socialist ideas emerged from the core (England, France,
Germany) as a response to the ugly early stages of capitalism. It also took
roots in the outside-European periphery where its ideals were accepted as a
way of breaking up the imperialist exploitation from the core. Interestingly,
this was far from the scenario envisioned by Marx and Engels in the
Communist Manifesto. They considered the peripheral countries of Eastern
Europe too backward to ever accept the revolutionary ideals of social
progress. Not to mention the countries outside of Europe and the colonies.
Their goal was clear: a proletarian revolution was supposed to take place in
Germany because of their early lag behind Britain and France in the 19th
century.16 But socialism became particularly attractive in underdeveloped
countries, and for a good reason—it offered a way to catch up with the
developed countries of the core, particularly given the Russian experience.
Russia was the first country in the world to embrace communism,
instituting it violently through the Bolshevik October Revolution in 1917.
Notwithstanding other attempts at communist revolutions in Hungary,
Germany, Spain, and outside of Europe during the interwar period, it was not
until after World War II that socialism became widely adopted across
Eastern Europe and the rest of the developing world. The Soviet Union was
the central power and it held the utmost authority over interpreting the
Marxist-Leninist doctrine, particularly over countries in Eastern Europe,
with the notable exception of Yugoslavia after 1948 and the Tito-Stalin split.
Politically, the communist doctrine recognized an authoritarian system that
was necessary to fast-track industrial development and shift the
underdeveloped agricultural countries into modern industrial strongholds,
perfectly capable of competing with the Western core. Or at least, that was
the narrative. Killing and imprisoning dissidents, landowners, the
aristocracy, certain members of the old elites, or anyone who opposed the
doctrine, was justified as purging the country of the enemies of progress and
the legacy of the revolution. This ideological justification is particularly
interesting when considering contemporary politically socialist countries like
China, which uses the same justification to promote what is in essence
capitalist economic growth (hence the reason why China’s model is political
capitalism,17 not socialism).
Nevertheless, the authoritarian political system was successful in
achieving robust economic growth via a rapid, state-managed transition from
agricultural jobs into industrial jobs. Sometimes this led to disasters, like in
China during Mao’s Great Leap Forward, where people were given
unrealistic production targets and were forced to tear down parts of their
houses to meet the metal export quotas, or faced starvation to meet the
agricultural quotas. The Soviet Union also underwent episodes of famine and
scarcity in the interwar period, however as they completed their switch to an
industrial economy in the 1950s, stronger economic growth was an obvious
consequence.
Eastern European countries embarked on the same path from the early
1950s when the shift began, although to a varying level of success
determined by the prewar levels of development, and with differences in
how the regime was established. In some countries the revolutionary
movement was endogenous, developing internally while rising to power,
while in others it was imposed exogenously, primarily through Soviet
occupation in the immediate aftermath of the war. The consequence was that
the new socialist regime was considered as imposed by a foreign power
rather than authentic in many Eastern European countries, which created a
strong demotivating factor within the population. Countries that developed
their socialist governance authentically had a much stronger internal
justification and greater support from the majority of the population. This
affected the postwar development given the different motivational factors in
rebuilding the country.
Table 8.1 shows the cumulative GDP per capita growth in the 30-year
period (1950 to 1980) of rapid growth in the periphery compared to the
current European core countries and the so-called Eurozone periphery
countries, followed by a 10-year decline and stagnation (1981–1990) in the
final decade of socialism (only Czechoslovakia was marginally better in
1990 than it was in 1980), and then the next 20-year period, where GDP per
capita first went down in the early stages of transition, recovering only in the
late 1990s and early 2000s for the 10 new EU member states (those entering
the EU in 2004). I show GDP per capita rather than pure GDP growth, as the
per capita values are a better indicator of how economic development
benefited the population.
Table 8.1 Cumulative growth of GDP per capita from 1950 to 1980, from 1981 to 1990, and from 1991
to 2018. GDP per capita is in US dollars, 2011 prices. Three groups of countries are compared: the old
periphery including the Soviet Union and the entire Eastern Bloc (1–8), the countries of the current
European periphery, defined as such during the Eurozone sovereign debt crisis (9–13), and countries of
the current European core (14–21). There was no data for individual countries of the Soviet Union, but
there is separate data for the countries of former Yugoslavia (for which the opening year is 1952*). The
estimates for East Germany are for the years 1950, 1973, and 1990 (**). The estimates for the Soviet
Union and Czechoslovakia after 1990 are estimates based on their former member country’s rates of
per capita growth (***). This was not done for Yugoslavia since some of its countries are already
included in the Table. Source of data: the Maddison Historical Statistics (2021)
Country Av. annual Av. annual Av. annual GDP GDP GDP GDP p/c
GDP per GDP p/c GDP p/c p/c in p/c in p/c in in 2010
capita growth growth growth 1950 1980 1990 (USD)
1950–1980 1981–1990 1991–2010 (USD) (USD) (USD)
1 Soviet Union 2.80% 0.70% 2.3%*** 4,529 10,245 10,989 16,345***
2 East 3.30% –1.90% – 2,794 7,695 5,402 –
Germany**
3 Poland 2.90% –1.10% 4.80% 3,900 9,149 8,150 20,609
4 Czechoslovakia 3.30% 1.40% 3.2%*** 4,736 12,336 14,178 25,922***
5 Hungary 3.20% 0.30% 3.50% 3,953 10,052 10,296 20,036
6 Yugoslavia 5.20% –1.00% – 2,276 10,037 9,000 –
6a Croatia* 6.20% –0.90% 2.10% 2,738 14,193 12,948 19,511
6b Slovenia* 6.40% –1.50% 1.90% 3,934 21,151 18,093 26,001
6c Serbia* 6.30% –0.90% 1.80% 2,032 10,724 9,754 11,964
7 Romania 6.10% 0.30% 5.70% 1,046 5,482 5,596 16,377
8 Bulgaria 4.50% –0.70% 2.70% 2,632 9,634 8,922 14,686
Average (1– 4.56% –0.48% 3.11% 3,123 10,973 10,303 19,050
8)
9 Italy 4.50% 2.20% 1.50% 5,582 20,959 26,003 34,766
10 Greece 5.30% 1.10% 2.60% 3,052 14,300 15,964 26,517
11 Portugal 4.70% 3.10% 2.00% 3,325 12,822 17,526 25,463
12 Spain 4.80% 3.20% 2.60% 3,464 14,008 19,215 31,786
13 Ireland 3.10% 3.30% 4.90% 5,504 13,614 18,838 48,624
Average (9– 4.48% 2.58% 2.72% 4,185 15,141 19,509 33,431
13)
14 United 2.10% 2.40% 1.40% 11,061 20,612 26,189 34,754
Kingdom
15 France 3.60% 1.80% 1.30% 8,266 23,537 28,129 36,087
16 West Germany 4.40% 1.20% 2.50% 6,186 22,497 25,391 41,110
17 Netherlands 3.10% 1.60% 2.40% 9,558 23,438 27,515 43,812
18 Belgium 3.30% 1.80% 1.60% 8,706 23,060 27,412 37,739
19 Sweden 2.70% 1.70% 2.20% 10,742 23,809 28,068 42,635
20 Austria 4.50% 2.10% 2.00% 5,907 21,932 26,930 40,288
21 Switzerland 2.90% 2.30% 2.60% 11,541 23,060 34,250 57,219
Average (14– 3.33% 1.86% 2.16% 8,996 22,743 27,986 41,706
21)
 Notice a few interesting facts. First, the average annual growth of GDP
per capita for socialist countries in the 30-year period of rapid growth was
almost the same as those of the Eurozone periphery (around 4.5%), but
somewhat larger compared to the growth of the European core (4.5%
compared to 3.3%). This is, as we mentioned, normal and expected
according to the economic convergence theory—countries at a lower level of
development converge faster. In 1950, the European core was three times
richer on average than the socialist periphery, while in 1980 it was only
twice as rich—hence these countries managed to slightly close the gap. The
Eurozone periphery was also closing the gap, and rapidly so, continuing to
do the same in the next 30 years, when the socialist periphery entered into its
relative stagnation and could no longer keep up. Notice the differences
between West and East Germany. In 1950 West Germany was 2.2 times
richer than East Germany. In 1980 it was almost 3 times richer, while in
1990, after a decade-long decline of GDP per capita in East Germany, West
Germany was 5 times richer. East Germany grew, but it failed to catch up.
Second, the final decade of socialism in every country shows that the
economic model was clearly exhausted and entered a period of stagnation
and regression. While the Western core and periphery kept their GDP per
capita growing at 1.8% and 2.4%, respectively, the Eastern Bloc collectively
declined by 0.5% and found themselves relatively poorer at the start of
transition than 10 years earlier. The early years of transition saw huge
declines in both GDP and living standards across the Bloc, with significant
increases in unemployment and poverty. However, by the end of the 1990s
and early 2000s, most Eastern European countries bounced back and again
started catching up with the West, growing more strongly than other European
countries (with the exception of Russia and former Yugoslav countries). In
2010 they were back to where they were in the 1980s with respect to the
developed nations, with countries like Czechia and Slovenia even surpassing
some of the peripheral European countries. Eastern Europe lost a lot of
ground over the 15 years from 1980 to the mid-1990s, but most of them
managed to bounce back and reverse all that regression. It took them 15 years
to replace the lost 15 years.
However, many countries failed to fully catch up and get back on the pre-
1980s trends, among them many former Yugoslav and Soviet states. This
brings us to the third fact—there were obvious between-country differences
in the socialist periphery, both during socialism and afterward. During the 30
years of socialist growth, Romania, Bulgaria, and Yugoslavia, for example,
were growing in GDP per capita faster than the Soviet Union and the rest of
the Bloc, whose countries were actually developing slower than most of the
Western core and periphery. Countries under strong Soviet influence, with
foreign-imposed socialism, clearly had lesser incentives for strong,
endogenous growth. However, even among the fast growers, there were
obvious differences.
Romania, for example, started from a very low level of development,
being a truly agrarian economy in the aftermath of the war. Both there and in
Bulgaria, the state’s central planning had an immense role in driving
industrialization, however this failed to fully translate into better living
standards for its citizens. Heavy industry was indeed strong, but there was no
consumerism. As the Eastern Bloc copied the West, they could produce the
same quality steel or plastic for example, but nowhere near the same quality
automobile or TV. This is why both Romania and Bulgaria continued stronger
growth after their transition, as did Poland, Hungary, and Czechia: the rise of
consumerism further propelled their economies.
Yugoslavia was an exception. It was the first country to break away from
dominant Soviet influence and engage a different economic model than the
rest of the Bloc. It opened up its foreign trade with the West and the rest of
the world, driven primarily by the political influence of Tito and the Non-
Aligned Movement, which opened up Yugoslav exports to Africa, Asia, and
South America. Domestically, it opened its borders to foreign tourists
(something quite rare in Soviet-dominated countries), and introduced more
consumerism to its citizens than any other country of the Eastern Bloc. Its
economic model was a combination of strong industrialization and
urbanization initially, but by the 1970s it was an export-led growth, boosted
by the participation of its labor force in the West (which enhanced the flow
of remittances, increasing domestic savings).
The one common pattern for the entire Bloc was the stagnation and
decline in the 1980s up until the mid-1990s, driven by the imminent failure of
the socialist economic model and the effects of transition. In Yugoslavia this
was exacerbated by a political crisis from within “initially” driven by
“Serbian” nationalism and territorial aspiration which caused a devastating
war. Countries most hurt by the war—Croatia, Bosnia and Herzegovina, and
Serbia—were left clearly lagging behind the rest (the per capita data for
Croatia and Serbia are actually driven more by a population decline due to
emigration than by robust economic growth). Even 30 years after the fall of
socialism, these countries have failed to reach their pre–1980s trend of
catching up with the West.
A final implication is the fast pace of development. It took the three
selected countries in Yugoslavia only 30 years to increase their GDP per
capita by 5 times. In comparison it took Britain 150 years, taking 1820 as the
reference point, to increase their GDP per capita by a factor of 5. France
needed 134 years to do the same, Austria 136 years, Germany 109 years, etc.
The progress that happened across three generations in the United Kingdom
or France, happened in a single generation across most of Eastern Europe.
This might have even been too fast. During such a quick process of
industrialization there was little time for the population to adapt to massive
changes, to develop a successful system of checks and balances or the
necessary institutions and public goods that would suppress the
antimodernization legacy of the agrarian society. Furthermore, given that the
modernization process was imposed by communist governments, often
violently, there was a necessary pushback that shaped the feelings of people
who were wronged or mistreated by the system. Tribal allegiance remained
important and could not be modernized during a single generation. People
born in the 1940s, ’50s, and ’60s grew up in typical agrarian communities.
The socialist baby boomers lived through three industrial revolutions within
a single lifetime, and despite accepting the benefits of progress, certain
aspects of the old mentality are still present. In the core this progress was
much more gradual, allowing people to adapt across generations, with every
new generation feeling less burdened by an agrarian, tribal heritage.
The modernization process, even in countries whose growth was less
impressive, was rapid. Infrastructure investments were the biggest sign of
progress: more factories, energy grids, telecommunication grids, ports,
roads, and railroads were built in those 30 years than at any time before or
afterward. The rate of urbanization picked up significantly, as cities
expanded and had to build more residential buildings and supporting
infrastructure like schools, kindergartens, and hospitals. A good measure of
industrialization is the decline in the share of agricultural population for the
socialist countries, which was around 50% on average in 1950 (and over
60% of the workforce), only to end up at around 10% by the end of the
1980s.
 In three decades, the shift from an agricultural to an industrial society was
achieved. However, keep in mind that the same trends of rapid infrastructure
expansion also happened in most nonsocialist European countries at the time,
particularly those of the current Eurozone periphery, whose growth was also
impressive. Heavy industrialization and rapid development of new
infrastructure objects was indeed the main trend of the second half of the 20th
century. The main difference between the West and the East was that socialist
countries started from a much lower initial level of accumulated capital and
hence their progress seemed more impressive. Socialist nondemocracies thus
managed to achieve the same level of progress as did capitalist democracies,
at least in those 30 years. The socialist experiment at the time was thus
considered a great historical success. In the 1960s and 1970s Western
economists were predicting that it is only a matter of time before the Soviet
Union overtakes the United States by size of GDP. The developed West in the
1970s underwent a period of stagflation, while the socialist East was still
reaping rewards from its accelerated industrialization and urbanization.
Without the benefit of hindsight, in the 1970s one would think that the
socialist model had no boundaries. But then the music stopped.
The socialist growth model ran out of steam in the 1980s. Most socialist
countries started incurring large foreign debts to keep the momentum.
Inflation was another problem and currency devaluations a constant worry;
standard issues of emerging market societies embarking on the “original sin”
of not being able to borrow money in their domestic currencies making them
more vulnerable to outside economic shocks—specifically the oil crises of
the mid-1970s and 1980s. The latter in particular signaled the beginning of
the end of the socialist economic model as domestic savings and
consumption declined and economies entered a decade-long stagnation.
While the Western core started embarking into the Third Industrial
Revolution (the IT revolution), and as globalization picked up pace, the rigid
central-planning system simply could not pick up.
Socialist governments of Eastern Europe did not know how to lead a
transition from an industrial to a postindustrial society the same way they
managed to spearhead the shift from an agrarian to an industrial economy.
This was true for one basic reason: technological progress and innovation
cannot be planned and managed. Planning the shift toward industrialization
was possible given that socialist governments copied the processes that
occurred previously, over a much longer time period, in England or
Germany. Central planning systems can be relatively good at copying but are
ineffective when it comes to creativity as they lack the internal incentive and
capacity to innovate.
As the socialist economic model in the periphery collapsed, the transition
toward democratic capitalism began. However, this transition was merely
figurative, and once again brought the violence power principle into the fore.
The transition was, in most cases, led by the former socialist political elites,
all of which with proven failures to successfully manage the previous
economic crises. They condensed power and shifted it into new party
formations, only formally respecting the newly established democratic
standards (such as multiparty elections and new constitutions), while at the
same time enabling cronyist control of resources and dubious privatization
schemes which favored the politically chosen well-organized minority
(mostly composed from the old communist elite networks). The oligarchs
created during this process contributed to a rise of inequality as wealth was
concentrated in the hands of a politically selected elite network. The
consequences, besides rising inequalities, were increases in unemployment,
emigration, and a decline of GDP and living standards.
This is hardly surprising, at least according to the research done by
Albertus and Menaldo, who show that democracies are created “by the elites
for the elites.” They find that during times of democratic transitions the
former regime elites determine the rules of the new democracy, rules that
primarily serve to promote their interests, rather than the interests of the
median voter. They design electoral rules, write the constitutions, and shape
all other institutions, such as the justice system, to serve their benefits and
keep them in power. The authors find that two-thirds of democracies were
created by the old elites, where these elites could even determine the timing
of when a democracy can be introduced, leveraging it for their benefit. This
obviously increases inequality given that the institutions of a new system
benefit the old elites. Democratization is thus a deliberate process designed
by the elites, rather than a random event that arises from popular uprising.18
Hardly anyone gives power up voluntarily. They strive to preserve it and
when faced with undeniable and unmitigable trends, they adapt, negotiate
concessions, and build a position that protects them.
This argument can serve as a useful explanation of why democracies have
failed to eliminate inequality—it was never part of their design nor their
goal. Democracies have, as a consequence of capitalism, succeeded in
alleviating poverty, but have failed to account for the problem of elite power,
the root cause of inequality. Even when democratic societies enter a
developed phase of inclusiveness and prosperity (when they enter and
remain in the “Narrow Corridor” maintaining a stable balance between the
power of the state and the power of society19), there is no guarantee they will
succeed in mitigating the violence power incentives that propagate the
concentration of wealth and power within elite networks.
However, as argued earlier, despite these initial issues which all early
democracies go through (recall the Tammany Hall example from 19th-century
New York mentioned in the Introduction), their trial-and-error process does
eventually right the wrongs and helps build a more just and prosperous
system. I am therefore optimistic in the capacity of capitalist democracies to
solve the inequality issue without resorting to violence. As the final chapter
will show, in order to do this, another evolution is necessary—the
empowerment of the society with a goal to constrain the power of the elites.
We must start with reducing centralized power and shift that power back to
the citizens and the community.
⋆⋆⋆
The 20th-century socialist model managed to deliver rapid industrialization
to the periphery, which was still mostly trapped in an agrarian economic
system after the end of World War II. However, due to a lack of the very
basic trial-and-error process, due to a lack of capacity to innovate and adapt
to the new trends of globalization and the IT revolution, it reached its
inevitable end after the period of rapid industrialization. The socialist model
was not immune to elite networks, and it too failed to curtail their incentives
for power and wealth accumulation. This made it vulnerable in its transition
phase to capitalist democracy as the old socialist elites spearheaded the
process in most countries, resulting in an unsuccessful transition marred by
cronyism and corruption.
The socialist model failed in solving the violence power principle—if
anything it enhanced it—meaning that it failed in reducing elite network
power, the cornerstone incentive for unequal wealth accumulation. The
reason for this failure was primarily its inability to innovate and use the trial-
and-error process that capitalist democracies have proven to be particularly
good at. Both systems can end in congestion, economic crises, and deliver
erroneous and malign outcomes, but when democracies face such situations,
if their institutions are strong enough, they can learn, adapt, and innovate
themselves out of the crisis. When socialism faced its first major crisis,
because of its lack of capacity to innovate, it was destined to fail.
We must therefore ask the next logical question: if capitalist democracies
have a tendency for innovation and change from within, driven sometimes
spontaneously and sometimes by intelligent design, what would be an ideal
set of policies or reforms to drive such a gradual change that would tackle
the source of inequality? Before we answer this question in the final chapter,
let us consider the standard proposals for curbing inequality in the next
chapter: taxation and redistribution.
 9
The Pitfalls of Political Power
Expanding the Scope of Government to Reduce Inequal
ity

Politicians and diapers must be changed often, and for the same reason
—Mark Twain

9.1. Progressive Taxation

In light of the historical lessons presented in the previous chapter, where
democratization gradually evolves and over a longer period of time creates
different incentives that improve social outcomes through benevolent
governments, we have to ask ourselves is there a way to use the
encompassing power of governments to solve the problem of inequality and
lack of opportunity?
Higher income taxation and redistribution are often advocated as the main
policy choices to combat the issue of rising income inequality. The problem,
however, is that such policies are focused on alleviating the consequences—
unequal incomes—but not the causes—proximity to political power. Their
goal in reducing incentives for inequality is likely to be ineffective.
The main reason why advocates of redistribution and taxation support
such measures is because they see unequal incomes primarily as a
consequence of market failures. If the market fails to achieve a distribution of
income that society deems fair—implying that too many are being left out of
the benefits from economic growth, or that some groups are simply taking too
much economic gain for themselves (measured as the share of income among
the highest income earners versus everyone else)—the government should
step in and tax those with higher incomes, while redistributing these funds to
those at the poorer end of society, not just in terms of transfers but also in
public goods such as better health and education opportunities. In addition,
higher taxes on the rich would create disincentives for very high wages at the
top, thus further lowering the market-generated inequality.1
The central problem with this reasoning is that inequality is only to some
extent a consequence of market failures. Political failures, in the form of
abuse of political power through elite networks, are a crucially overlooked
source of abnormal earnings among the top 1% and 0.1%, just as they were
the most important source of wealth concentration among the elites prior to
the 19th and 20th centuries. As shown in Chapter 4, political connections of
top executives in the United States and the United Kingdom are an important
explanatory factor of higher salaries and total compensations. These two
countries were the forerunners in rising inequality trends over the past
decades, driven primarily by the growth in incomes of top income earners. In
each case, all other market, nonmarket, and networking variables explained
very little of the variation in top incomes.
However, distinguishing the market effect from the political effect is
difficult to do using official statistics of tax returns (which is how inequality
is being measured, today more accurately than ever before). Although we can
distinguish between different types of earnings—for example rents,
dividends, or other forms of capital gains, and we can even see if one’s
income is entirely generated from inheritance or whether rents are driven by
political decisions—we cannot see why a top executive’s salary is higher.
We can only speculate and cite reasons like tax cuts, or the combination of
globalization and the skills premium, standard examples of market
determinants (i.e., demand) for top executives. Which brings us back to the
issue of progressive taxation as a policy with an aim to lower incentives for
high salaries at the top.
The standard justification for introducing progressive taxation can be
visually inferred from Figures 9.1 and 9.2. Top marginal tax rates hit their
highest ever levels across many developed economies in the period from the
1930s to the 1970s. Top rates went up as high as 98% in the United Kingdom
during the 1940s, and over 90% in the United States in the 1950s, albeit
slightly lower in Germany and France during the same period when they
reached 75% and 66% respectfully, shown in Figure 9.1. During the same
years, inequality (measured as the share of income held by the top decile
earners) in all these countries was at its historical lows, going down to 31%
on average from as high as 50% in early 1900s, as shown in Figure 9.2.

Figure 9.1 Top income tax rates for the US, UK, Germany, and France from 1900 to 2020. Source: Pik
etty (2020), data available at: http://piketty.pse.ens.fr/fr/ideology.
Figure 9.2 Top decline share in total income for the US, UK, Germany, and France, from 1900 to 2020.
Source of data: World Inequality Database, https://wid.world/.

In the 1980s, the income tax system became much less progressive, and
inequality shot up once more. Top rates were halved and stood at 30% in the
United States and 40% in the United Kingdom, however they remained
relatively unchanged in Germany and France in the 1980s, only going down
to less than 50% in the 2000s (when inequality started increasing in
Germany). Similar trends happened in other European countries. The West,
the United Kingdom and the United States especially, never returned to the
high-income tax rates of the mid-20th century (although France had a brief
experiment in 2013 and 2014, which is examined in the next section).
Economic research also finds a link between tax policies and inequality
since the 1980s. In Chapter 3 I mentioned a countrywide study of OECD
economies conducted by Piketty, Saez, and Stantcheva, who find that the
reduction of top marginal tax rates increased the bargaining power of CEOs
with respect to their boards, thus increasing their salaries and other benefits.2
Furthermore, they find that the top 1% of earners take advantage of tax
evasion opportunities, meaning that an optimal policy should be aimed at
eliminating any possibility of tax avoidance.
 In a study that surveyed the literature on tax policies and their impact on
inequality by Saez, Slemrod, and Giertz, it was found that tax evasion
significantly increases for those with higher incomes, as does their effort to
avoid taxes with respect to higher tax rates.3 They cite the episode of the
Reagan tax cuts in the United States, after which a considerable number of
wealthy individuals reported a one-time increase in taxable income, meaning
that those people brought back their wealth from abroad to take advantage of
the tax amnesty clause. When tax evasion loopholes are closed, taxable
income becomes insensitive to tax rates, meaning that one can, theoretically,
get more government revenues by increasing top tax rates without reducing
work effort. It is the same argument Piketty uses in his books to advocate for
a more progressive income tax and a global wealth tax.4 This theoretically
justifiable conclusion might, however, be very difficult to implement in
practice, as we will touch on in the following sections.

9.1.1. The Unprecedented 30-Year Period That Brought Down In

equality
Before doing that, let’s get back to the trends from Figures 9.1 and 9.2,
specifically focusing on the historical implication of high top income tax
rates during and after the 1940s. Can these postwar trends really suggest a
causal implication between progressive taxation and income inequality? In
other words, did income inequality go down mostly because of progressive
income taxation?5 Or were there other, much deeper and more important
forces at play?
For one, the biggest declines in both income and wealth inequality
occurred during a 30-year period that saw two world wars, between which
there was a pandemic that killed even more people than the first war,
revolutions, the Great Depression, and episodes of hyperinflation that erased
a lot of wealth for many. The rapid decline of inequality during those times is
much more likely a consequence of the wars and their aftermath than of the
social reforms (franchise extension, the welfare state) that were introduced
not with a goal to reduce inequality, but as a reaction to the wars and
economic depressions, hoping to prevent such events from ever happening
again.
Immediate consequences of World War I in the West included the full
extension of the franchise to the population demanding greater representation,
huge public debts, and war reparations that were being repaid first by
galloping inflation and soon by hyperinflation, particularly in Weimar
Germany, and a corresponding increase in taxation and introduction of
income taxes to additionally pay for the aftermath of the war. Even the rise of
the Spanish flu pandemic can to some extent be attributed to the war, given a
population with weakened immunity becoming fertile ground for the rapid
spread of the virus. In Russia, the direct outcome of the war was the
dissolution of its empire through a revolution, and the rise of communism and
central planning. The Russian brand of communism would carry on for over
70 years, achieving particular momentum and prominence after World War II,
providing at the time a powerful alternative to the Western model of
capitalist democracies.
The Great Depression resulted in the first big battle of ideas between the
then dominant doctrine of laissez-faire capitalism and the central planning
alternative offered by Soviet Russia. President Roosevelt’s New Deal—
introducing social security and unemployment relief, worker protections,
major financial and regulatory reforms aimed at consumer protection, public
work projects, and of course, new redistributive taxes—was exactly the type
of reform package that shows how societies were adapting to the major
social pressures of the time. Preventing another economic depression was the
central issue of those turbulent times.
Until soon after the Depression, when World War II began, and rendered
an even stronger effect on the distribution of incomes and wealth. Destruction
of property aside, the biggest negative effect on wealth and incomes was the
aftermath of the War. A wave of nationalizations and expropriations of
private property spread across Europe, not only in newly established
socialist countries but in capitalist democracies like France and the United
Kingdom.6 Almost entire industries were nationalized; from banking, to gas
and electricity, the coal industry, and the automobile industry.7 Furthermore,
public debt was an even bigger issue than after World War I. Countries once
again started printing money to pay it off, thus again causing inflation to rise,
with efforts like price controls and food rationing applied to prevent it. This
added to the misery of the population in the first four to five years
immediately after the war, particularly in Germany and France. Personal
savings were virtually wiped out. To prevent another hyperinflation episode
and pay off the war-induced public debt, progressive taxes were increased
and other forms of taxation introduced.
 In the battle of ideas the pendulum swung away from laissez-faire
capitalism toward a mixed economy, hoping to get the best out of both a
strong social security system and a market economy. Nowhere was this more
obvious than in West Germany, whose first postwar government pledged to a
social-market economy (Soziale Marktwirtschaft), a third way approach
between the Anglo-Saxon laissez-faire capitalism and the central planning
system they had during national socialism. It was a market economy with a
strong welfare state, the embodiment of European capitalism in the decades
to come. Introducing a strong welfare state happened in almost every
developed postwar economy. Atlee’s government in the United Kingdom
introduced the NHS, providing public health care, in addition to a number of
other reforms that cemented the welfare state. The United States expanded on
Roosevelt’s reforms during the 1950s, culminating in Lyndon Johnson’s Great
Society in 1965 introducing Medicare, Medicaid, and federal education
funding. Societies changed, reforms were introduced, and the democratic
trial-and-error process delivered.
Wealth and income concentration at the top were clearly subdued, as so
many factors contributed to their decline. Progressive taxation was a mere
drop in the bucket among all these paradigm-shifting events. Events that
coincided and occurred over only three decades—two major, unprecedented
wars, a pandemic, hyperinflation, economic depressions, revolutions—are
the most blatant personification of the forces of occasional destruction. All
four of Scheidel’s “Four Horsemen” happened in that relatively short time
span. Inequality obviously went down. The social reforms instituted
afterward were initiated to prevent these events from ever occurring again.
They were not targeted to combat inequality. Their role was to rebuild their
societies and prevent economic depressions and the outbreak of another
devastating war. Inequality was an afterthought.
Claiming that the same set of ambitious reforms would have occurred had
it not been for the wars or the depression is simply not rooted in fact. The
wars and the depression were obviously not exogenous events, they were
driven by internal pressures and were a typical example of a self-reinforcing
negative cycle of the forces of occasional destruction. A number of political,
economic, and social pressures combined and delivered such outcomes,
where each one merely exacerbated the others. Inequality was hardly the only
cause (or even a major cause) of such events, and it was certainly not the
main concern during the aftermath of the war when the structural reforms took
place.
After such unprecedented events it took a while before the forces of
wealth accumulation picked up pace once again. Another shift in the
pendulum of the battle of ideas in the 1980s certainly helped the forces of
wealth accumulation (as was shown in Chapter 3), but it would be wrong to
constrain the cause of such forces to a mere policy change or a set of policy
changes. Incentives for wealth accumulation, gained through access to
political power, are persistent.

9.1.2. The Artificial Decrease of Inequality

Which brings us back to the main issue of progressive taxation and its
inability to deal with the causes of inequality. In addition to a doubtful impact
of higher top tax rates on the considerable decline of mid-20th-century
inequality, there is also a structural problem in why they tend to be less
effective in a more globalized world. Capital today is more flexible and
travels faster than ever. Incidences of tax evasion are quite common, as they
are highly correlated with the complexity of a country’s tax code. This might
be a deliberate consequence of the political process, given the effort of
lobbyists in designing tax legislation to make the system more opaque and
hence more prone to loopholes. Because of this a higher tax on top incomes
could only lower inequality artificially by incentivizing wealthy individuals
to hide their true earnings and wealth overseas.
I refer to this as an artificial decrease of inequality given that the official
income tax statistics would show lower top incomes, thus lowering the
shares of top decile and top centile earnings in total earnings, but only
because a part of those earnings would be taken out of the country to an
offshore tax haven. In other words, real inequality would be hidden, not
solved.
A study of tax evasion using the “Panama Papers” and “Swiss leaks” from
HSBC for three Scandinavian countries, Norway, Sweden, and Denmark,
unsurprisingly confirms that tax evasion increases with wealth. In particular,
in these countries tax evasion is about 3% of all personal taxes, but among
the wealthiest 0.01% it is close to 30%. When this is taken into account, the
inequality numbers in Scandinavia go up significantly.8 This research
highlights the importance of going beyond income tax data to fully capture the
extent of inequality in a country. As the authors state, even in countries where
tax compliance is high, as in Scandinavia, the full extent of one’s tax
avoidance cannot be captured by the available data,9 meaning that inequality
is likely to be underestimated, particularly in countries where social trust is
lower and corruption is higher than in Scandinavia.
Given that the very definition of elite network members are people in the
top income brackets who (mis)use their power for private gain, it is highly
likely that tax evasion is higher the more powerful someone’s position in the
elite network hierarchy. This means that raising taxes on these individuals
will hardly solve the actual inequality issue. It will only hide it. Closing
loopholes and strengthening international tax compliance, despite being the
theoretically optimal policy, is almost impossible to enact. Offshore
countries have strong incentives to attract wealth this way (whatever effect
this might have on their local economy). This is why the solution must be
found elsewhere, beyond a set of stand-alone policy proposals.
There is a good recent quasi natural experiment that testifies how the
mechanism of an artificial decrease of inequality works. It concerns
President Hollande’s introduction of the 75% top marginal tax rate on annual
earnings greater than €1 million in France in 2012. Hollande campaigned on
this tax in 2011,10 and announced its implementation soon after he won office
in May 2012. The French high courts approved the tax in 2013 (given that it
was ruled unconstitutional a year earlier), and the tax had been applied to
fiscal years 2013 and 2014, ending abruptly in January 2015 after it was
proven woefully ineffective.11
French billionaires were outraged by the announcement of the tax.12 Many
declared they would be leaving the country, the most prominent examples
being the richest man in France, Bernard Arnault, the CEO of Louis Vuitton,
who took out Belgian nationality, and the famous actor Gerard Depardieu,
who got Russian citizenship.13 Other less prominent billionaires either
shifted their wealth abroad or started buying real estate in London14 (a trend
that would significantly increase demand for London’s high-end real estate in
the years to come).
The tax itself failed to produce the desired effect. It halved the
government’s tax revenues in 2013, not just from income tax but also in
corporate tax revenues and VAT revenues.15 It did, however, result in a slight
decrease in top 10% and top 1% income inequality, as shown in Figure 9.3.
Top 10% share in total income fell from 32.2% in 2011 to 30.9% in 2013,
while top 1% share in total income fell from 10.4% to 8.9% in the same
period. When the top tax rates were reduced to 45% in 2015, top 10% and
1% inequality again shot up (to 31.9% share of total income for the top 10%,
and back to 9.8% for the top 1%).

Figure 9.3 Income inequality in France measured as the share of income for the top 10%, top 1% and
bottom 50% share. Source of data: World Inequality Database, https://wid.world/.

Why did inequality rebound so quickly after the top rate was scrapped?
To understand this effect, we must examine the estimated tax evasion in
France during the same period. Figure 9.4 shows the total offshore wealth of
French citizens from 2001 to 2016, estimated officially by the European
Commission. There is an interesting trend of increasing offshore wealth that
started in 2011, expanded in 2012, and culminated in 2014. In that three-year
period, offshore wealth of French citizens increased by 79% cumulative
(from €169bn to €342bn). The trend was reversed after 2015, when the 75%
top tax rate was scrapped.
Figure 9.4 Estimated offshore wealth in France, 2001–2016. Source: European Commission (2019)
“Estimating International Tax Evasion by Individuals,” Taxation Papers, Working paper no. 76, European
Commission, September 2019, page 67.

Furthermore, the French government lost an estimated €51bn of potential

tax revenues due to evasion. The four-year period that revolved around
Hollande’s tax hike saw a particularly strong increase in lost revenue due to
tax evasion on original income, as shown in Figure 9.5. As did offshore
wealth, the revenue loss from evasion started decreasing in 2015. These tax
evasion trends, coinciding with the period of highest tax uncertainty in
France, suggest that the numbers verify the sentiment of French millionaires
and billionaires at the time. It also suggests that with offshore wealth being
as high as €360bn (13% of French GDP), amounting to a €50bn loss in tax
revenues (5% of annual revenues), capital is indeed very flexible and can
hardly be contained by methods of economic policy alone.
Figure 9.5 Estimated losses in tax revenue due to different versions of tax evasion in France, 2004–
2016. Source: “Estimating International Tax Evasion by Individuals,” Taxation Papers, Working paper
no. 76, European Commission, September 2019, page 192.

There could, of course, be other reasons why evasion occurred, and this
short quasi-experiment is not enough to make a causal implication on whether
higher top marginal tax rates induce tax evasion of the rich. Anecdotal
evidence is never enough to make such a conclusion, however economic
research across many countries does confirm that higher tax rates typically
result in higher tax evasion. This was confirmed in the United States for
capital gains tax and for income tax,16 in China for high tariffs on imports,17
in Switzerland and Italy for income tax,18 and so on. Each study finds a
strong negative effect of tax increases on noncompliance, and in many cases
the studies also report a loss of tax revenues after higher taxes were
introduced. Just like the effect in France after the 75% top marginal rate.
Another thing this short quasi-experiment showed is that increasing the
top marginal income tax rate fails to address inequality in real terms. The
main problem with models calculating the impact of progressive taxation is
that they assume everything would stay the same and that the wealthy would
not shift or otherwise hide their incomes after a high marginal income tax rate
is introduced. The anticipated gains from high top marginal rates would
evaporate if the wealthy simply shifted their earnings overseas, meaning that
this revenue could not be used to finance health, education, climate change,
or poverty programs, as so eloquently advocated. There would be no such
excess revenue from taxation to redistribute, and the only consequence of
high marginal tax rates would be to encourage cheating and tax evasion.
Higher income taxes would certainly lower (hide) inequality observed in
the earnings data, as they would lower the share of top decile and top centile
earnings. Measured inequality would therefore go down, but real inequality,
real differences in opportunities, wealth, and earnings between the
politically connected rent-seekers and the politically unconnected majority
would remain high and possibly even increase if more redistributive power
is granted to those who generate top 1% income inequality in the first place.
As this book has repeatedly shown, real differences in incomes and
opportunities arise from proximity to power, from the elite network effect
that makes sure that any regulatory or legislative changes benefit the elite.
When the tax code is deliberately complex and opaque this is a direct
product of lobbying and legal efforts by the wealthy to legally hide their
income abroad.
A typical counterargument from advocates of progressive taxation is to
introduce stricter laws that can prevent tax evasion globally. The
impossibility of international policy coordination on this issue aside, even
the domestic legislative process, unfortunately, does not work so smoothly
and easily. Every draft of legislation gets watered down significantly before
it is voted into law, usually to include many loopholes. Loopholes, counter to
popular perception, are not a product of systemic glitches or someone’s error
in judgment. They are deliberate and a typical outcome of the political
decision-making process. Any person who ever worked as a legislator is
familiar with this. Various interest groups fight to promote their interests in
the political arena, but in this battle between competing interests those with
the quickest proximity to power tend to get the best outcomes. This is why it
is difficult to change gun laws in the United States, or why demand for higher
taxation of the rich, even with popular support, rarely gets passed in the
legislative assemblies.19 Going back to the spectrum of interest groups
delivered in Figure 1.9 in Chapter 1, the elite network members—the new
supermanager elite, clustered in the upper right part of the diagram having
high salience and high power—will hardly ever get punished by the political
process. Therefore, the only way to solve the elite network impact on the
political decision-making process—the key driver of inequality—is to
change the process: reduce political power, and reduce our dependency on
politicians to make such decisions.
By increasing taxation and advocating for a greater role of the state to
solve redistribution issues and impose additional regulations to prevent
adverse political outcomes like collusion, we are inadvertently advocating
handing greater power to politicians. And by doing so we are exacerbating
negative selection into politics and are increasing systemic fragility. Which
brings us to the next argument of why it is futile to depend on political power
in order to reduce inequality.

9.2. Adverse Selection into Politics

If a career in politics guarantees access to power, it will undoubtedly attract
power-hungry individuals with questionable moral views and almost entirely
selfish motives. Psychological research has uncovered that an increasing
number of political leaders exhibits psychopathic or sociopathic tendencies
(incidentally, the same applies to corporate leaders).20 Granting even more
incentives to such individuals to obtain power seems absurd and
counterproductive to the very idea of trying to achieve fair social outcomes.
Politics obviously also attracts genuinely honest individuals with a strong
moral compass (something we like to define as “true leadership”), however
even a remote probability of having a sociopath in power necessitates trying
to find a solution to prevent such an outcome, or even better, never to grant a
sociopath any significant power to begin with. Particularly if the probability
of choosing a morally corruptible individual is (considerably) higher than
choosing an honest individual.
Think of it in terms of a battle between competent and incompetent
individuals in politics and public service in general. If you are an
incompetent yet ambitious individual, loyalty and allegiance to your party
and your leader are the only things you can use to advance in your career.
Competent individuals do not have to show such blind loyalty, they hope to
advance and achieve their ambitions based on merit: their skills and
knowledge. However, in a contest between a competent and incompetent
individual, even within-party, the incompetent individual has everything to
lose from a defeat, whereas the competent one can always choose an
alternative path. This creates strong incentives for incompetent but ambitious
individuals to win under all costs, which morally corrupts them during their
path to power. By the time they reach office they are burdened with debts to
people who helped get them there (unless they get rid of them immediately,
which is a strategy directly pulled from an autocrat’s handbook). Selecting an
incompetent or morally corrupt leader seems to be a higher probability
outcome than selecting an honest incorruptible leader. Even when such an
honest, competent leader is chosen, there is still the issue of selection of all
the people around them. Changing one person does not change tens of
thousands of individuals underneath, all of whom were selected under the
same principles of political selection: ambitious and morally dubious
incompetence beats morally superior competence in the majority of cases
simply because incompetence has much more to lose and hence is more
likely to try and win under all costs. It is the violence power principle in
action.
There are, of course, positive examples of countries where the civil
service is made up of mostly honest and competent individuals, where its
employees perform their jobs with a sense of pride and duty and seldom hold
back progress with unnecessary burdens or corruption. In such countries,
politicians get drawn from the same pool of honest and competent
individuals and are driven by the motivation to serve their countries, not to
usurp power for private gain. These are countries that, according to
Acemoglu and Robinson, learned how to contain the power of their
Leviathan (existing within the “Narrow Corridor” between weak states that
deliver anarchy, and strong states that deliver authoritarianism),21 countries
that built institutions that constrain political power, and immediately punish
every politician that tries to break the boundaries, even for benign affairs
(like buying chocolate and diapers with the government credit card).
These are also countries where trust in public institutions is high and in
which people do not mind paying higher taxes if they know these taxes will
deliver the public goods that benefit their communities. The best example are
Scandinavian countries, where most people believe in the fairness of the
process and know that any politician that tries to command too much power
or misappropriate the vast public resources at their disposal will quickly be
punished (the aforementioned credit card example is of a former Swedish
minister). Such a mechanism exists in countries where governing institutions
are depersonalized, where the question of who holds power does not infringe
in any way the institutions that preserve the “Narrow Corridor” balance.
Scandinavian elites also avoid paying their taxes, as shown earlier. But they
do not usurp political power to protect them. At least not as much to harm
social progress.

9.2.1. Personalization of Governing Institutions

The personalization of governing institutions is probably the biggest
difference between well-functioning democracies and poorly functioning
democracies. In countries with depersonalized institutions societies are
governed by clear rules that everyone respects. These rules are a product of
a long trial-and-error democratic process and are widely accepted by
everyone in society to be fair. As societies evolve the rules change, again to
the general acceptance and desire of the society (civil rights movements are
good examples). Most importantly, in such countries rules do not change by
the will of a single person or narrow group holding power. The power-
holders merely adopt the changing norms if demanded by the majority.
Switzerland is a perfect case-in-point. Policies change when people vote for
such changes in referendums. Politicians in power are merely executors of
the peoples’ will. They are respected, they are drawn from a pool of honest
and competent individuals, and yet they have very low incentives of ever
usurping their political power for private gain. Mostly because their political
power itself is constrained by the rules of the game which they cannot
change. In such countries elite networks are likely to be less effective simply
because individuals at the position of power do not carry the biggest
decision-making weight. Proximity to power does not give a person the
leverage to alter legislation to serve narrow interests.
On the other hand, many corrupt democracies suffer from the issue of
personalized institutions. This is best described by North, Wallis, and
Weingast in their theory of violence and social orders. Countries
characterized as limited access orders are those in which well-organized
ruling elites can manipulate the economy by generating privileges based on
the personalization of governing institutions. In such systems all political and
economic outcomes are merely a consequence of interpersonal relationships
among agents within the ruling elite networks. When the institutions of a
system are depersonalized it is much harder to create clientelist
relationships. This is the case of an open access order, in which the
foundation of intrapersonal interactions is a well-defined, depersonalized
legal framework, and not politically generated privileges.22
When institutions are personalized, people start demanding too much from
politicians and think that the person behind the institution is the institution.
This is dangerous ground for populists to exploit, given that they thrive in
environments where they can personify the government and build a cult of
personality around themselves. But the problem runs deeper than that, and it
often ends up backfiring against the populists. When a government is
personified by the person or a group of people in charge, we start demanding
too much from those leaders. We place too high of a burden on a centralized
system which is by definition unable to solve as many problems as we think
they are apt to solve. In such situations our natural inclination is to expand
the powers our leaders can use to solve our problems. We are looking for the
messiah, the one leader that can save us. We are assigning idealistic
characteristics we would like our leaders to have in order to be competent
enough to solve all of our and, by extension, the society’s problems. And we
keep fooling ourselves that it is just a matter of electing the right person for
the job. But this rarely happens. A much more likely outcome for a leader
with such power is to misuse it for personal gain, to enjoy it without facing
much accountability. We never find the “right” person, because in societies
with weak and personalized institutions, the adverse selection into politics
effect is only amplified and keeps delivering incompetent power-hungry
individuals.
Another consequence of personalized institutions is increased incentives
for corruption, not just in national-level governments but throughout society.
When the system fails to solve a given issue—which happens quite often—
people seek to befriend or reach individuals making the decisions. The
decision-making position on any level therefore grants the individual even
greater power. In corrupt countries this is true whether the issue at hand is a
court trial where interested parties seek to find a connection to a judge, or
getting a building permit, where one seeks connections to public officials
making the calls, or a medical procedure, where it is key to be in proximity
to the doctor, or at least be able to bribe them. When institutions are
personalized, the system fails to deliver optimal outcomes, and when the
system fails, people turn to individuals making the decisions to solve their
problems. It is a vicious cycle where it is often hard to pinpoint the direction
of the causal relationship.
 Countries with high levels of inequality will typically be countries where
institutions are personalized, where selection into politics is skewed toward
power-hungry individuals, and where corruption tends to be higher.
Personalization of institutions is a breeding ground for elite networks. One
does not befriend systems or institutions, but people. Being close to the right
person making the decisions implies getting favorable outcomes.
Personalized institutions have no room in successful democracies. And
personalized institutions have no room in countries that want to lower
inequality.
The United States is a specific case here. It does have a strong
institutional system that prevents a number of malign undemocratic outcomes,
while many of its institutions are indeed depersonalized. However, in the
case of the Trump presidency we witnessed how fragile even these strong
institutions can be. The United States did not descend into autocracy, nor did
the Trump administration manage to disrupt the justice system or change the
way American democracy works. Nonetheless, many elements of
democracies were under threat, the reason for which was too much power
concentrated in the hands of a single person who completely personalized the
institution of the presidency. Regardless of the strong constitutional
constraints that every president has, even this is sometimes not enough given
the pure magnitude of decision-making powers given to the president.
Particularly when it comes to foreign policy where US presidents have been
virtually unconstrained (the only constraint was the size of their domestic
budget subject to Congressional approval). The United States is without
doubt a strong democracy. Its institutions work. But given that these
institutions can be stretched by a single person holding power—and hence
personalizing the institution of the presidency—perhaps time has come to
constrain the power of the executive branch in the United States, and demand
less from politics.
Which bring us to the necessity for lowering centralized political power
and lowering the scope of activities for national-level politicians. A
necessary condition for this to work are stronger incentives to prevent misuse
of power in terms of greater transparency and accountability. There is a need
for reform aimed not at the consequences but at the root causes of malign
outcomes in our societies. Behind them is always too much extractive
political power.
 This is not an inherent argument against government, redistributive
taxation, public services, or the necessary public goods in situations where
markets fail to provide an optimal social outcome. This is an argument first
and foremost against the people behind the government; their incentives and
motivations. This is an argument aimed at lowering political power.

9.3. The Importance of Trust

The problem with personalized institutions, in addition to skewing selection
into politics, is that it also erodes trust in a society. When people seek
individuals instead of institutions to solve their problems, they have no trust
in the system. As emphasized before, this is a vicious cycle with no clear
direction of causality, but the underlying factor that drives people to seek
outside-institutional solutions is lack of trust. On the other hand, countries
with depersonalized institutions imply a population that trusts the system to
work and deliver the public goods the people desire. In such countries
paying taxes is not met with incentives for evasion, but with a genuine desire
to give back to the community.
Interestingly, lack of interpersonal trust seems to be a factor that binds
most countries with the issue of high inequality, regardless of their levels of
development or their economic system (with the exception of China and
Saudi Arabia, where interpersonal trust is high for other, mostly historic and
religious reasons—see Figures 9.6 and 9.7). Figure 9.7 in particular shows
an interesting correlation between interpersonal trust (the question of
whether or not most people in a country should be trusted) and the Gini
coefficient. The correlation is negative and shows that countries with higher
levels of interpersonal trust typically have lower levels of income inequality.
This does not imply a causal relationship between trust and inequality,
simply because there might be a common unobservable factor that affects
both these variables. It is, nevertheless, interesting to note that countries with
higher levels of interpersonal trust also trust their governments more and that
this trust seems to be quite consistent over time (like in Scandinavia or
China).
Figure 9.6 World map of interpersonal trust, based on the World Values Survey and how many people
agree with the statement that “most people can be trusted.” Source: Ortiz-Ospina and Roser (2022).

In the United States, trust in government (measured as % of people who trust

their government) dropped from 77% in 1964 down to only 19% in 2015.
The decline has been sharp in the mid-1960s and ’70s (due to the Vietnam
War), rebounded in the early ’80s, had a sharp decline in 1992, rebounded in
the late ’90s and has been in a steady decline since 2001 (when it was at
48%), again as a consequence of the Afghanistan and Iraq wars and possibly
the 2008 financial crisis.23 Interpersonal trust hasn’t fallen so sharply nor has
it been so volatile, but the long-term trend is still negative, from 45% in 1972
to 30% in 2014. It might not be a direct cause of inequality, but rebuilding
trust—especially trust in public institutions—is certainly an important factor
in strengthening the democratic trial-and-error process.
Figure 9.7. Correlation between trust in others from the World Values Survey (2022) (x-axis) and the
Gini coefficient from the World Bank (2020) (y-axis). Source of data: Ortiz-Ospina and Roser (2022):
“Trust,” https://ourworldindata.org/trust.

Another reason why trust is important is its role in perpetuating social

progress. Sociopolitical systems in which people don’t trust each other and
don’t trust their public institutions are breeding grounds for populism and
conspiracy theories. This can best be seen in rapidly declining levels of trust
in experts and scientists, particularly noticeable in developed countries of
the West during the COVID pandemic (although the distrust in experts was a
trend that started years, even decades before the pandemic). Everyone, the
government especially, is portrayed as having a secret agenda, which raises
suspicion and increases the plausibility of off-the-shelf conspiracy theories
about things that were never before being brought into question—things like
vaccinations, communication networks, or even evolution.
There are plenty of social, political, and even economic factors that have
contributed to the spread of conspiracy theories and fake news (the Internet
and social media being just some of them). The reason for their persistence
has been a steady erosion of trust in governments and experts who can easily
dismantle every conspiracy theory and keep it on the fringes of society. But
when there is no trust in public institutions, conspiracy theories move away
from the fringes and into the mainstream. By doing so they can deliver bad
social and political outcomes, something we might call an error in the
democratic trial-and-error process. These periods of error can last a long
time and result in extreme political polarization and distrust of anyone who
disagrees with one’s opinion. It leads to mass creation of cognitive bubbles
(echo chambers) where you only trust people inside the same bubble, while
carrying massive distrust toward everyone outside of it, toward people who
do not share your worldview.
Continued lack of trust is therefore a certain path toward dysfunctional
societies. The economic logic of such societies is a zero-sum game where
one’s gain must equal another person’s loss, preventing any incentives for
robust economic growth and development. Such societies stay embedded
within a self-perpetuating bad equilibrium where the only way to break the
cycle is a long, protracted process of rebuilding trust through the democratic
mechanism. Given that the democratic process itself is extremely fragile,
especially in dysfunctional societies, it very often fails to deliver the change
in trust, but this is only because it is being used in the wrong way. We will
see in the next chapter which types of reforms are crucial to rebuild trust
among people, within communities, and for public institutions. Only with
higher levels of trust can we start rebuilding dysfunctional societies.
Which is why the set of policy proposals presented in the final chapter
lists rebuilding trust as the key necessary condition for re-empowering
communities and lowering elite network incentives. If we wish to reduce
incentives for inequality, we must forget about solutions that aim to expand
political power, or solutions that focus only on inequality’s consequences.
Solving this deeply entrenched issue requires a long process that falls
outside the scope of a single set of policy changes. It rests on the democratic
trial-and-error process, it rests on a long road to rebuilding societal trust,
and it rests on lowering the magnitude of political power. Hopefully this
chapter has shown there are no magic bullets. The process is tedious, and
must be met with patience and open-mindedness.
 10
The Three Levers

Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.
—Archimedes

Men are moved by two levers only: fear and self-interest.

—Napoleon Bonaparte

10.1. Moving beyond Standard Approaches: Introducing the

Three Levers
A set of reforms that seeks to reduce inequality needs to take aim at the main
factor that has historically been responsible for higher concentration of
wealth among the elites—political power. This is no easy task, and there is
certainly no one-size-fits-all solution. Elite concentration of wealth driven by
political power has been a persistent pulling factor throughout human history.
It is not something that can be transformed by a one-off policy change.
Changing incentives for elite wealth concentration needs to be designed
with second- and third-order consequences taken into account. A reform
implemented today should aspire to change behavioral patterns of
individuals and politicians (first- and second-order effects) which would
ultimately reduce incentives to misuse political power, lower the allure of
elite networks, and hence reduce inequality (third-order effects).
Take the idea of full transparency of budgetary spending and, ideally,
decision-making behind budget allocation decisions, one of the proposals
examined under the First Lever. Full transparency implies that every single
receipt a government-owned entity spends money on is made publicly
available for all to see: major procurement contracts, including the annexes
of such contracts where no information is withheld, wages of public sector
employees, and all small expenditures such as lunches, dinners, or travel
expenses. The consequences would be to discourage all involved in the
budget allocation process from cheating and misallocating resources (first-
order effect), which would reduce incentives to misuse public office for
private gains (second-order effect), which would improve selection into
politics and increase political accountability (third-order effect). This is by
no means straightforward to do, nor does it guarantee a successful outcome,
given that a policy change rests on changes in expected behavior in the future.
To make the change stick it needs to be gradually introduced while
simultaneously encouraging civic participation, namely monitoring of
political decision-making by the media and interested citizens.
One important point that needs to be addressed here is the issue of
complexity when designing public policies. Complexity renders real costs to
the policymaking process, costs which are seldom discussed when proposals
are made. Many of the laws and regulations enacted today are unnecessarily
long and detailed, burdened with a goal of providing an encompassing
solution to each issue. This detailed regulatory approach, because of the
exponentially expanding complexity of the society it aims to regulate,
typically creates unwanted effects in the form of loopholes, either done by
design or by accident, hidden in the vastness of the mere size of each
legislative proposal (such as the 850-page-long Dodd-Frank financial
regulation bill, or the 1,200-page-long Waxman-Markey climate bill). The
United States and the EU have witnessed the rise of an army of regulators and
bureaucrats over the past half century. And while their motivations for
improving the system are certainly genuine, they often produce adverse
effects that increase informational asymmetry benefiting those with access to
it.
Elite networks, because of their topocratic nature, are the first group to
benefit from asymmetric information. Exploiting loopholes in the tax code is
a prime example. The inequality literature consistently shows how the
wealthy (many of whom are elite network members) are the only ones with
the ability to hire legal counsel to dwell through the intricacies of complex
tax codes in order to reduce their own tax burden. The rest of society lacks
this advantage and is stuck in navigating the added complexity of the
regulatory requirement. The same applies to big firms as opposed to smaller
firms. An increased regulatory burden takes a much higher toll on small
businesses than it does on big business, usually the prime target of said
regulations. Considering that a large part of inequality can be explained by
between-firm differences, adding complexity to the regulatory process hardly
helps solve the inequality issue. If anything, it exacerbates it.
The EU General Data Protection Regulation (GDPR) mandate is a case in
point. It was motivated with a very specific issue: to prevent Big Tech firms
like Google or Facebook from misusing their users’ data. The initial goal of
the legislation was to dampen the business models of online advertisers who
used personal data of its users to predict their behavioral and spending
patterns and sell them targeted products (from goods and services to political
candidates). However, instead of putting even a dent in Big Tech business
models, the legislation only added a layer of unnecessary burdens on every
single firm with a webpage in how it handles its client’s data. But it had an
additional unwanted effect that was much more damaging: it lowered
transparency of the public sector in some EU countries. What was usually
under the jurisdiction of the “right of access to information” is now hidden by
bureaucrats who refuse to provide information on how a certain decision
was made (say over allocating a procurement contract or on nepotistic hiring
practices), calling on GDPR to shield themselves from further legal inquires.
GDPR became a cloak of invisibility for bureaucrats and politicians. In low-
trust and high-corruption environments, it is rendering a direct negative effect
on transparency and the rule of law. So much for thinking about complexity
and second- and third-order effects while enacting a piece of legislation.
Regulatory complexity cannot cope with societal complexity, no matter
how detailed it becomes. An effort to fix an issue by adding layers upon
layers of regulatory documents only adds to the inefficiency and seldom
solves any issue. Not to mention the thousands of hours needed to comply
with the regulatory requirements. The goal of effective policymaking should
be to introduce clear and simple rules that limit power, and reduce
complexity of the regulatory code. Therefore, the policy proposals made
here, aimed at curbing elite network power, must not fall into the trap of
adding unnecessary complexity. They must aim at relaxing legal and
regulatory procedures and replacing them with simple rule-based policies.
The presented set of policy reforms, coalesced in the form of Three
powerful Levers aimed at lowering political power and increasing civic
engagement and trust, is designed with second- and third-order effects in
mind, and with an aim to reduce regulatory complexity in its solutions, never
to add to them. The goal is to use the trial-and-error mechanism of the
democratic process through simple enforceable rules to lower incentives of
elite network wealth and power accumulation and consequentially lower
income and wealth inequality.
By now it should be obvious to the reader that all proposed reforms will
seek to rebuild trust in public institutions and rely on the trial-and-error
democratic mechanism. We can therefore define Three Levers that, if applied
simultaneously, would gradually reduce incentives for elite network wealth
and power accumulation by exploiting the trial-and-error mechanism and
rebuilding social trust. I use the term “lever” as an apt analogy. Archimedes
required a single lever to “move the world,” Napoleon relied on two—“fear
and self-interest,” but in order to help democracies overcome elite networks
and lower inequality, we need three. All three rest on Archimedes’s
metaphor of why a lever is useful, and at least one uses some variant of what
Napoleon had in mind.
The Three Levers are:
1. Reducing political power—introducing greater constraints on public officials; introducing full
budgetary transparency to increase political accountability; lowering scope of centralized
government decision-making activities
2. Re-empowering the citizens—paying out gross salaries to people who use part of their tax
allotments to directly determine how they are to be spent; introducing mandatory participatory
budgeting for community public good provision; giving citizens an option of a credible imminent
threat against transgressing office-holders
3. Re-empowering the community—greater decision-making given to communities over the
distribution of local public goods

Note that the Levers reinforce and rely on each other. Greater community
engagement implies lower centralized political power and the ability of
citizens to make choices over the allocation of their tax money into local
public goods. Greater citizen empowerment in terms of greater power over
the allocation of tax payments implies a stronger community in which they
can express their interests. Lower political power implies greater community
power and greater power given to citizens to hold politicians accountable.
Finally, and most importantly, do keep in mind that the given set of
proposed policies was not a product of my explicit research efforts, nor
were they tested experimentally and thus proven to work. They are a
subjective extrapolation of some of the arguments made in the book. If
political power is the issue, we need to understand how to reduce it and
make the political process work to our benefit. The reform proposals are
purposely designed to be provocative, hopefully stimulating the debate to
take another direction, away from the usual set of policy proposals. Let’s
explain each in greater detail.

10.2. First Lever: Reducing Political Power

When it comes to reducing political power, trust in public institutions is once
again the crucial issue to address. Three reforms in particular can serve as a
mechanism to improve trust, improve political accountability, and change
selection into politics—all three of these are particularly important in
corruption-engulfed countries and dysfunctional societies:
1. Deliver full transparency of budgetary spending and decision-making in order to uncover all
potentially fraudulent deals between politicians, interest groups, and connected firms;
2. Encourage and promote free media and investigative journalism;
3. Introduce term limits for political office and strict conditions that prevent anyone charged with
corruption to run for public office.

In addition to rebuilding trust and introducing institutional safeguards we

must simultaneously implement solutions that reduce discretionary political
power. The following proposals can deliver the biggest long-run benefit in
that respect:
4. Reduce discretionary decision-making power from office-holding politicians. Impose rules as
credible threats that imply immediate punishment for politicians (key performance indicators for
politics).
5. Reduce the scope of activities office-holding politicians have the power to influence.

The point of each of these reforms is depersonalization of institutions. In

order for the system to work it should not matter who holds political office.
Political power needs to be decentralized, where public good allocation
decisions are collective instead of individual, thus preventing any individual
(or a narrow group) from usurping power. The institutional changes proposed
under the First Lever seek to be the first step toward turning politicians and
office-holders into true public servants; nothing more than executioners of the
people’s will, with an important role in the process of public good
allocation.

10.2.1. Full Transparency of Budgetary Spending and Decision-M

aking
As shown in the previous chapter, the majority of countries in the world
suffer from lack of interpersonal trust and, by extension, trust in public
institutions. This can generate unwanted consequences and reduce any
impetus for social change, thus condemning a society to a self-perpetuating
negative cycle of increasing polarization and decreasing trust. There is no
easy way of breaking this up, and there is certainly no unique recipe,
otherwise many societies would have already applied it. In order to rebuild
trust, there are only microsteps: small bottom-up changes that gradually
restore confidence within a society. Trust, like confidence or reputation, once
lost, is very difficult to reinstate. Marginal changes and efforts must be made
to improve it.
The first such marginal step, a bottom-up type of reform, is full budgetary
transparency. In itself it is a very simple idea: through the use of basic digital
technology—a website with a search engine that makes it easy to access
information from a spreadsheet—give the public direct insight into every
single transaction, every single receipt made by a public entity, whether it is
a local government, a national government, every ministry, every public
agency and regulatory office, every public firm (e.g., a utility company or a
similar natural monopoly under public ownership). Full and complete
transparency implies every single transaction; from small payments (lunches
and dinners, travel expenses), to major procurement contracts, to gross
salaries of all public employees. It also includes all details of transactions:
dates, amount, details of the person or firm that received funds (name and a
unique personal identifier), description and justification of the expense—in
other words, everything that goes through an accounting software of a public
entity should be available for the public to see. The government, acting like a
true servant to its people, should have nothing to hide in front of them, at
least in terms of how it spends the taxpayers’ money.
The first immediate impact of introducing full transparency is to lower the
motivation for corruption and increase political accountability. In corrupt
countries a digitalized easy-to-use overview of all government transactions
and decisions is a powerful tool to prevent fraud in procurement allocations
or one-sided changes in urban planning laws (the two biggest sources of
corruption). Furthermore, it can monitor all recipients of government
donations and subsidies in an effort to prevent political vote buying, while
reducing the possibility of nepotism or employment based on political party
membership. Transparency also reduces inefficient spending practices, as the
bureaucrats in charge of administrating the decisions are fully aware they are
being monitored and scrutinized. This might happen frequently on a national
level where there is greater media oversight, but on a local level or among
public firms, such detailed scrutiny is almost nonexistent. Finally, having a
user-friendly online tool increases civic participation and encourages
citizens toward more active cooperation with the local government in solving
the problems of their community.
This might seem like a somewhat radical idea, but a system of budgetary
transparency already exists, at least on some national or supranational levels.
In the United States, every single transaction from a $4.8 trillion federal
budget is freely available for anyone to use, search and download through a
simple online search engine.1 Even supposedly secret transactions of
acquiring combat weapons and military equipment by the Department of
Defense (DoD) are all listed. For example, the search engine shows that the
DoD awarded over 2.6 million contracts in 2019 worth over $250bn. Each
contract is easily accessible and one can browse through its details (such as
the type of weapon and how many of them were bought) as well as the details
of each company that received the funds, and how much money they have
received from the government altogether.
Similarly, the European Commission keeps a website called the Financial
Transparency System2 that tracks funds that were distributed via various EU
grants from the European Commission. A person can search through each
Member State and see all organizations and individuals who received an EU
grant from the Commission since 2007, including the amount, the purpose,
and individual and firm details. However, these are only grants given to
Member States, and do not list all expenditures of the Commission,
something that would be a welcomed step forward.
These are positive examples of national or supranational budgetary
transparency, and although they are a commendable effort in the right
direction, they are not enough to rebuild trust in public institutions,
particularly in corrupt countries. The approach to full transparency must be
broad-based, follow a very specific standard of not hiding any important
information, and potentially start on a local level from which it can be scaled
up nationally.
Furthermore, in addition to the exact amounts and receipts of the money
spent, the public should also be able to look behind the reasoning of every
single budgetary decision. Transparency in decision-making is the next
logical step for countries that already have some form of budgetary
transparency. This implies justifying every single expense to the public, from
small payments and official trips, to procurement contracts and decisions
over changes in urban planning laws. It could be set up on the same website
tracking individual expenses, where alongside each expense or government
decision there is a detailed justification and explanation that illustrates how
and why such a decision was taken.
For example, for every procurement process the public should be able to
know why an offer was accepted and why other offers were rejected.
Typically, such decisions are hidden under a cloak of bureaucratic
procedures and poorly written laws. Having the public be aware of such
practices is the first step toward improving the efficiency and fairness of the
process. The same goes for decisions on urban planning laws, when the
government decides to change agricultural land into construction land—the
public should be informed as to which individual or company stands to
benefit from the changes. This would make it easy for the public or the media
to keep track of all connections between politicians and those who benefit
from their decisions. Needless to say, such transparent procedures will
drastically reduce the motivation for anyone to request specific favors from
politicians, as the outcomes of such favors will be publicly accessible for
everyone to see. Full transparency also reduces asymmetric information
surrounding government decisions and access to information. It is a great
example of an easy-to-implement, easy-to-follow, and relatively cheap
solution that helps start the process of rebuilding trust in public institutions
and increasing civic participation for better government accountability.

10.2.2. Encourage and Promote Free, Independent Media

In order for transparency to yield maximum impact we need engaged citizens
and we need someone to keep track of all potentially fraudulent deals or
decisions. In other words, we need free, independent media, and in
particular, investigative journalism.
What is the optimal way to encourage free media? On one hand, we can
have a trustworthy, independent public media outlet like the BBC in the
United Kingdom. However, in most countries, especially ones with high
levels of corruption, public broadcasters tend to be prone to political capture
—they serve the party in power and deliver biased news. In corrupt
countries and countries where public institutions are captured under the
control of one-party rule, public broadcasters are often the worst sources of
fake news and propaganda. Such instances of media capture by governments
have been well documented in economic research,3 and proven to have a
strong positive association with inequality.4
On the other hand, we can have private media outlets, but they too can end
up captured and promote personal or political interests of its owners or
otherwise distribute fake news and undermine the role of free media in
society. Examples here are ample. The most prominent is the case of Rupert
Murdoch’s media companies in the United Kingdom, culminating in the phone
hacking scandal and the Leveson Inquiry. Another is Berlusconi’s private
media empire in Italy which was very successful in hiding any evidence of
the prime minister’s wrongdoing (Berlusconi also held firm control over the
public television RAI, capturing almost the entire media scene in Italy at one
point). Examples of private media companies spreading fake news are even
greater, best epitomized in tabloid newspapers which reach a large following
and have immense power in determining the political landscape and shaping
public opinion. Politically biased broadcasters may even influence elections,
shown empirically on the example of Fox News and the 2000 Bush vs. Gore
election in the United States.5
However, in most democratic countries there are at least some media
outlets that are, in fact, independent, led by real investigative journalists, and
help uncover various cases of fraud and political scandals. Their discoveries
and investigations are often the only way the public would ever find out
about a political or corporate transgression. It is often the case that
investigative journalism provides enough evidence and public pressure to
start criminal proceedings from the authorities. The authorities seldom react
to anonymous tips, but once a scandal becomes public and is present in the
media, the authorities have to react. Free media can truly be considered a
cornerstone of democracy. It is a public good in its own right.
The problem is that such independent outlets are very often on the verge
of staying solvent. Particularly if they get slammed by lawsuits, which can
either silence them, reduce their sharpness, or push them into counterattack,
which further depletes their poor finances. Their societal role is priceless,
and yet, they are very fragile and often on the verge of being broken up,
typically by politicians and powerful individuals (the elite networks) they
investigate.
 How does one therefore encourage free and independent media? One way
would be through citizen empowerment, where people would choose to
donate a fraction of their donation allotment to free and independent media
outlets of their choosing. The donation allotment mechanism will be
explained through the Second Lever, but the basic idea is to give citizens
direct power to choose who they support with their tax contributions.
Whoever receives such support would still have to be competitive in
maintaining high standards in order to attract donations. This is especially
important in the digital age where information is abundant, however truthful
information is scarce and often hidden behind paywalls. Transparency is
important here as well. The media outlets that receive money from
individuals through tax contributions need to be very transparent about how
they spend it.
An alternative would be to have a public broadcaster or newspaper
devoid of any political interference. Achieving this separation from political
influence is relatively easy in countries with high levels of public trust, but
they don’t have the problem with political power to begin with. It is the low-
trust politically captured countries where such an idea is difficult to enact.
However, given that free media is indeed a type of public good that
strengthens a democracy, one way to ensure lack of political interference is
to pass a law that follows a nondiscretionary set of rules on how to distribute
funding to media outlets based on their influence (in terms of readership
reach or citizens’ donation allotments), the share of investigative
articles/cover stories reported per month, the share of articles/coverage that
led to open criminal or legal investigations, the share of educational
articles/coverage per month, and so on. This could be defined in an easy-to-
follow points-based system where different media outlets compete with the
quality of their reports and their outcomes. For example, if a political or
corporate affair is uncovered, the outlet that uncovers it is rewarded most
points, however every other outlet that covers the same story also gets points
(obviously much lower than the primary source), in order to encourage the
story about a scandal to spread. This may be obvious motivation in countries
with free media, but in countries with captured media when a scandal breaks
out, the captured media is often forbidden from covering it.
A big problem in enacting this type of solution is that it requires passing a
law, which is again dependent on having at least initial political support. It is
difficult to expect authorities in corrupt countries to empower the media
which can hold them accountable. In some cases, this might be superimposed
(e.g., in the European Union), but it again requires navigating through
domestic institutions which might be politically captured to begin with.
Bottom line is that in countries which already have free and independent
media, it can continue serving its function of promoting full transparency and
political accountability. They can continue encouraging civic engagement. In
countries where the media is captured, empowering the citizens would have
to be the first step before liberating the media.

10.2.3. Term Limits and Strict Conditions for Holding Office

The next major reform aimed at rebuilding trust in politicians and public
officials is to introduce strict conditions for those willing to run for public
office. Specifically, to impose term limits for every executive and legislative
office, and to set up a rule that immediately terminates a mandate if a
corruption scandal is uncovered. The goals are to promptly punish
transgressors, prevent a single person from holding power too long, and
ultimately improve selection into politics.
Term limits are a standard practice is some democracies, especially for
high positions of power. Their basic idea is to provide a nondiscretionary
rule that limits one’s ability to be in power for very long periods of time. The
institution is not a modern phenomenon. It has its roots in ancient Athens and
Rome, and in Renaissance Venice, Florence, and Ragusa (the Dubrovnik
Republic), where term limits were imposed on certain elected officials.6
However, even in developed democracies not all positions of power seem to
be term limited. Local government office-holders are rarely constrained in
how long they may run for office, and even though their power is limited to
their city, county, or municipality, in that local area their relative power is
quite high. For example, frauds in procurement contracts or biased changes in
urban planning laws are often administered at a local, not national level,
where local mayors have too much discretionary power to determine
outcomes. Such mayors can easily build minimum winning coalitions that do
not require a large number of people, keeping them in power for long periods
of time.
Chapter 6 introduced the concept of the selectorate theory,7 according to
which politicians, in the absence of accountability and oversight, may stay in
power for long periods of time if they build a coalition of supporters that
benefit directly from them staying in power. This so-called minimum winning
coalition in democracies implies various vote-buying practices and using the
help of key members of groups like unions or religious or ethnic
organizations to secure voters. In the corporate sector, companies tied to the
person in power have a strong incentive to donate to campaigns or otherwise
encourage votes for the office-holder.
Even in developed democracies, small winning coalitions are more likely
on a local level of governance where oversight, transparency, and
accountability are much lower. Areas in which politicians repeatedly win
due to their small but powerful winning coalitions are more likely to have
higher corruption, higher levels of inequality, and lower living standards, and
to be less developed than areas where a large winning coalition is necessary
to win or stay in power. As expected, small winning coalition areas keep
their corrupt politicians in power for long periods of time.
Term limits are one way to solve this problem. They are designed for that
very purpose, to prevent corrupt politicians with powerful winning
coalitions from staying in power for too long. Extending term limits to all
levels of government, especially local, is the first step toward breaking up
local elite networks. The proposition is to introduce a mandatory yet simple
and easy to enforce rule that allows only two terms in executive office,
typically eight years, after which the office holder is no longer allowed to
hold the same office, but may move up to higher office, again for a two-term
limit only.
The rule is to be adopted at all levels of government and all positions of
elected public office. This includes terms in legislative assemblies as well.
Parliamentary status is, however, a bit difficult to confine to a single term,
given that governments in many countries don’t always survive a full term,
prompting early elections. For parliament and legislative office, the
proposition is then to allow three full terms, with a maximum of 12 years,
after which the existing member is either replaced by their elected substitute
(if the 12th year happens to fall in the middle of a term) or is unable to
participate in the next election for Parliament. They can, however, run for
higher or lower executive office, provided that they never held other elected
office before.
The end goal of the term limit imposition is to enable better selection into
politics. To increase variation in the number of candidates who get to hold
power and change them often. This is particularly important in corrupt
countries where selection into politics is dominated by dishonest individuals.
If their time in office is limited, the attractiveness of holding office is
lowered.
This is obviously only the first step. A policy that can strengthen the term
limit imposition and further improve selection into politics is another rule-
based constraint that immediately terminates a mandate in office for a person
that has been officially charged with instances of corruption. The emphasis
here is on the indictment being official, meaning that it has to come as a
result of a police investigation for which a court order has been issued. If the
courts accept an indictment for a public official, and a politician needs to be
placed under arrest, his or her mandate is immediately terminated, and an
early election is called to fill a vacancy (if it is a public office that requires
an election).
Bear in mind that filing a corruption charge or opening an investigation is
not enough, nor is a media exposé of a corruption scandal. These could
easily be manipulated by opposition candidates or anyone who wishes to hurt
the politician in power. Not until the court confirms the indictment can the
termination clause be activated. The proposal is therefore to change the
election law with a specific article stating that any politician who is
officially indicted on corruption charges is immediately terminated from their
position in office, and is forbidden from running for elected office until the
charges are officially dropped. After the court hearings are over, if the
politician proves their innocence in front of the court, they are free to run for
office again. A problem in corrupt countries is that the legal system is often
captured as well. However, even if a potentially corrupt judge releases the
indicted politician, he was still ousted from office and has to run again to get
back into power. His seat is not immediately restored after his court
proceedings are finished.
Another potential issue with this proposal is the presumption of
innocence. Every individual is innocent until proven guilty in front of the
court of law. However, very often individuals who stand trial and are
accused of a criminal act spend time in jail (unless they make bail) during the
court hearings. Is their constitutional right infringed on given that they are
innocent during the trial, until proven guilty? Is a bail bond unconstitutional
toward those that cannot afford to pay it? Many EU countries have provisions
that clearly prohibit public officials accused of or under suspicion of corrupt
acts.8 A person holding public office, if officially indicted of misusing public
office for private gain, has lost a moral right to hold that office, until they
clear their name in the court of law. In the end, this is a purely political
decision, not a legal one. If within a society some politicians never get
punished by the voters for their transgressions (because they’ve built
powerful coalitions of interest that keep them in office), institutional rules
should be imposed to prevent such undesired outcomes. Political capture
should be prevented by every possible means.
Once again, this might seem like a frivolous suggestion in well-
functioning democracies, given that politicians caught in relatively benign
scandals resign immediately, not to mention when huge political corruption is
uncovered. A well-investigated media story is often enough to draw a
resignation of a politician, no matter how high-up the position. However, in
many corrupt democracies and anocracies, this policy is essential. In such
countries not even direct criminal investigations or jail time can throw
politicians out of office. They either enjoy national-level protection from
more powerful politicians or they managed to capture their electorate and
used elite network power to permanently preserve their positions, enjoying
uncontested power for 20 or even 30 years. This is why institutional rules
must be enacted to discourage such outcomes and deliver immediate
punishment automatically when a politician is indicted.
To sum up, this first set of policies is more relevant to countries with
higher levels of corruption, which lack transparency, have a problem of
corrupt politicians staying in office for too long, and have a serious problem
with media capture. In low-corruption, open access democracies the media
is already free and independent, transparency is much higher, and politicians
do get punished when caught in scandals. There is still room for progress
obviously, as even in advanced democracies the local government can
sometimes lack the same level of accountability and scrutiny as is the
national standard. Hence full transparency and term limits for every level of
public office are certainly necessary. However, a more applicable set of
policies for open-access democracies is to introduce incentives that
depersonalize public institutions and lower political power. Let us start with
lowering the scope of discretionary decisions.

10.2.4. Reduce Discretionary Decision-Making Power and Introd

uce Rule-Based Politics
One point of representative democracies is to elect politicians to make
decisions over the allocation of public goods on our behalf. Aggregating all
individual preferences into collective decisions efficiently and fairly is, in
fact, impossible.9 Representative democracies are thus the next best thing—
trying to aggregate individual preferences using elected representatives who
are given the power to express these preferences for us. Problems arise when
too many decisions are bestowed on politicians and when our expectations
exceed the capabilities of elected representatives. This is where the
regulatory complexity kicks in, creating incentives for mitigating the rules,
instead of simplifying them. As more and more complex decisions are
required, the decision-making process grinds to a halt, and room for
manipulation is opened. The process becomes too cumbersome, so people
seek shortcuts to get quick and favorable decisions in their favor.
Discretionary decisions made by individual office-holders are such
shortcuts.
Some decisions are meant to be discretionary. It shortens the process and
enables a quicker resolution. But it also gives too much power to those who
make the decisions. Too much discretionary decision-making implies that
individuals personalize institutions. If you want a favorable decision to be
made by a court of law, you seek favors from the judge making the decision.
The judge is not the law, he or she only upholds it. If you need a building
permit, and the process of getting one takes two years, you look to find a
public official to bypass the process and get it done quickly. If you are caught
cheating on your tax returns, you look to pull strings with the tax officials so
that they let you off the hook. When the system is woefully inefficient or
unjust, you seek your own version of justice and efficiency. Individuals
become susceptible to corruption simply because too much decision-making
power is bestowed on them. An institution should make decisions, an
institution should issue permits, and an institution should uphold the law, in
all cases following a clear set of widely acceptable rules.
Institutions are obviously made of individuals, each with their own set of
biases and ideologies, and each prone to cognitive illusions that cloud
perception. As consumers we are so easily influenced by simple marketing
tricks that skew us toward a particular product. Even before the rise of
online algorithms we got persuaded by price anchoring, different framing,
and visual distractions. As voters we are so easily persuaded by political
propaganda, fake news, political ads, and ever more increasingly, our social
media bubbles. We make most of our decisions, whether day-to-day or life
changing, influenced by confirmation bias, hindsight bias, availability
heuristics, overconfidence, and various delusions. We are motivated by
greed and self-interest, we follow crowd hubris, and are blindsided by our
ignorance of basic statistics.10 Public officials, themselves human beings, are
susceptible to the exact same delusions and manipulations as everyone else.
Even, and perhaps especially, when making important decisions on public
policy. When the stakes are high there are multitudes of individuals
attempting to persuade officials to move in one direction or another, playing
very often to their egos, something a person in position of power is
particularly sensitive to.
If certain market failures exist because we as individuals are prone to
manipulation, then political failures arise for the exact same reason.
Cognitive manipulations of public officials are, in fact, even worse than
consumer manipulations, for two reasons: (1) these are people we entrust to
make important decisions on our behalf, and (2) power clouds judgment
more strongly than any cognitive delusion or product ad.
For these reasons the institutions on which we depend to make fair and
impartial decisions on our behalf should not be subject to personal cognitive
biases or manipulations, but should instead follow clear and mandated rules.
Rules that can obviously be adapted and changed but only as a result of the
change in societal preferences mandated by the majority of citizens, and not
subject to the whim of an individual politician who wishes to bend the rules
and laws to their liking.
The legal system is the best example of this. When it works well, when it
follows a clear set of rules, even if such rules are based on common law
practice, it delivers fair outcomes and people place their faith in it. When the
legal system is broken, when it is personalized and subject to manipulation
and bribery of its officials, it cannot, by definition, deliver fair and impartial
outcomes. A successful, depersonalized legal system is often the crucial
difference between corrupt and incorrupt countries. It can be a major source
of inequality and wealth and power accumulation if it serves the elite
networks, and if the justices themselves are members of such networks.
Depersonalization of institutions might sound like advocacy for an
impersonal Kafkaesque or Orwellian dystopia where individuals are
coerced into submission by depersonalized bureaucratic processes. Far from
it. Depersonalization implies more emphasis toward building a fair,
institutional, rule-based approach to political decision-making and less
emphasis on discretionary political power, held by both bureaucrats and by
politicians. It is the negation of the Orwellian dystopia, where too much
power is granted to politics and corporations. The main goal here is to
constrain holders of power, not citizens.
To do this, democracies need to gradually build a system that promotes
rule-based solutions and rule-based credible threats, and practice less
discretion. Just like an efficient and fair legal system, political decisions
should be guided by the same principles. A decision is made by an
individual, but the individual is following a predefined rule-based approach
that cannot be bent to promote partial interests. Each judge certainly has
discretionary power, but no judge operating within a fair justice system
makes decisions outside their legal boundaries.
A rule-based approach to politics is envisioned as a system of automatic
circuit-breakers that are activated when a certain outcome is achieved. It is a
system of credible threats that pushes politicians to respect the wishes of
their citizens in having macroeconomic stability and efficient public good
provision. It is not a system of rules that defines all roles in a society. It is set
of automatic constraints for those in power, not its citizens.
For example, one such rule that binds politicians could be Warren Buffet’s
impromptu proposal of keeping the budget deficit under control. Buffet
suggested that if the budget deficit goes over 3% of GDP, every sitting
Congressman should be ineligible to run for office again. A similar proposal
was sometimes advocated for central bank governors: if a set of key
monetary policy targets (CPI inflation among them) is broken, the governor
should be dismissed. A real-world example of such a strong constraint was
the 2012 US fiscal cliff provision, an imposed rule that would have
automatically been invoked had the Obama administration failed to reach an
agreement with a Republican-led Congress over the fiscal reform package. If
no decision was to be made by December 31, a series of deep budget cuts
and big tax hikes would have been imposed which would have automatically
closed the deficit but also sent the economy in a deep recession. The outcome
of another uncertain bargaining game, the Brexit negotiations, hung by a
thread for over three years with the impeding threat of a no-deal Brexit. This
was a strong credible threat that forced the United Kingdom and the EU to,
eventually, reach a deal. These kinds of rules operate as a pure game of
deterrence: when there is a credible threat, people will be forced to
cooperate to avoid it, whether in nuclear wars, or fiscal cliffs.
The rule-based approach advocated here is more inclined to follow
Buffet’s proposal or the central bank constraint, where certain outcomes can
trigger immediate punishment of politicians and office-holders. Having such
rules, which everyone agrees are fair and which have the legitimacy to
trigger immediate punishment, are the best possible incentive for politicians
not to misuse their power and always be focused on delivering the common
good. These rules are designed to reduce the necessity for overregulating.
They serve to promote a simple and easily enforceable institutional
constraint, very transparent in its conditions, making public officials highly
accountable toward their electorates.
I will not advocate overly specific rules, as these must be decided by
individual countries based on their history and voter preferences (some
voters care more about inflation for example, others about unemployment),
but I will make a few suggestions as to what this might imply:
• Unemployment: if it goes up over an agreed-on amount the entire parliament11 and executive
government branch are dissolved and ineligible to run for office again. This might be manipulated
by politicians employing too many people in the public sector, so additional provisions are
necessary such as defining the relative upper limit of the private-to-public sector employment
ratio. Also, it is necessary to control for extenuating circumstances of unexpected spikes of
unemployment, like the one that happened during the COVID pandemic. In such cases, the
executive and legislative branches have 6 or 12 months to get the situation under control before
the rule is triggered. It is easy to see how motivated politicians would be to solve this problem
immediately to preserve their seats.
• Inflation and monetary policy: if inflation goes up too high for too long (above an agreed-on upper
level like 3% for over two years), the central bank governor and the board are all terminated
from their posts. Some countries, small open economies in particular, have no power over
inflation, so their monetary policy goals should adapt accordingly (e.g., exchange rate targeting,
or nominal GDP targeting). The rule can also be relaxed to allow the governor more time to get
inflation (or any chosen target) under control before the mechanism is exercised. It can also
include other extenuating circumstances like the situation in the labor market—if unemployment
is low, and inflation remains elevated, this might buy more time for the governor.
• Deficits, debts, and fiscal policy: the “Buffet rule” would suffice here, with a few modifications.
If the budget deficit or public debt go up above a predetermined level, the government and
parliament have 12 months to set it in order. If not, they are all forced to resign, call a new
election, and are forbidden to run for office again. This might seem excessive, but with such a
credible threat in place it is unlikely it will ever be invoked. Politicians will have very strong
incentives (fear and self-interest) to prevent it from happening. The US fiscal cliff and a “hard”
Brexit are examples of credible threats that never materialized. Office-holders made sure of it.
In terms of fiscal policy, there could be a strict provision of an upper limit to the total societal tax
burden, where no tax can be increased or new tax introduced if it increases the overall tax
burden to citizens and firms. A tax can be introduced only if it immediately replaces another tax,
without increasing the overall tax burden (a progressive tax can be introduced under such a
provision, but if a society chooses to tax the rich more, they must lower the burden of something
else). This is similar to having regulatory sunset clauses, or cases in which a new regulation
cannot be introduced without removing at least two old regulations. Furthermore, in line with the
tax practices in Switzerland’s direct democracy, a budget law can prohibit the government from
imposing new or higher taxes without the approval of its citizens. This may be determined
directly via referendums (held online, to reduce costs), which would make an important part of
the social contract between the government and its people.
• Other pressing issues like inequality, climate change, or even health and education outcomes over
the long run can also be subject to their own set of rules that trigger severe punishment of
politicians if broken. This is more difficult to implement than fiscal or monetary policies, and is
particularly more difficult to hold politicians accountable (who is to say which government is
more responsible for climate change issues or rising inequality?), but having long-term oriented
governments is crucial to promote socially desirable outcomes. The proposal, in this case, is to
punish governments immediately only if they digress from expected, predefined trends in health,
education, or climate outcomes (e.g., population not getting healthier, PISA scores getting worse,
CO2 emissions increasing, etc.)
Think of these rules as key performance indicators (KPIs) for politics. There
is very little we can hold politicians accountable for. During election
campaigns many broken promises are quickly forgotten, and voters fail to
punish politicians for their transgressions, very often because of poor
choices they are faced with. When given clear KPIs, for which automatic
punishment is applied, we can have institutional rules to do the punishment
for us. If asymmetric information is a problem many voters are facing due to
policy complexity and lack of accountability, clear and enforceable
institutional rules are the best way to solve such a problem.
Last but not least, what about congestion? When there are simply too many
rules to follow, and when some rules are in potential conflict with each
other? This could bring gridlock, and politicians would be afraid to push a
decision because a certain rule is preventing them. To prevent congestion and
gridlock arising from too many complex rules that might even be at odds with
each other, we must turn to the final reform proposal under the First Lever; to
reduce the scope of centralized decision-making.

10.2.5. Reduce the Scope of Centralized Government

Reducing the scope of government is not the same as reducing its size, even if
one can act as a catalyst for the other. Reducing scope of centralized
government, in the context of the theory and evidence presented in this book,
implies shifting decision-making over public good allocation from central
governments to local communities. Not local governments, but local
communities, as shall be elaborated in greater detail under the Third Lever.
The main idea here is to lower centralization and reduce the scope of
activities and decisions handled by national-level politicians, for all the
reasons elaborated in the previous sections, without giving any more powers
or responsibilities to local politicians. This reform is not a call for more
autonomy to local governments, as this only exacerbates lack of transparency
and lack of accountability. The shift must happen on a community level,
engaging more people in local public good provision.
In order to reduce centralized political power, we must constrain
national-level politics mostly to keeping overall macroeconomic stability
and delivering national-level public goods like safety, judicial independence,
public infrastructure, and the like. Local public good provision should be left
entirely on the community and its citizens to decide. The central government
can act as an aggregator of funds (through collecting taxes), it can—with full
transparency—redistribute these funds to communities, but cannot decide on
how communities should disburse them. The central government, guided by
the aforementioned clear and simple institutional rules, would retain the
ability to impose strong constraints on upholding judicial independence and
punishment for local-level transgressions. It is a system of checks and
balances between the central government and the community, where the main
role of the central government is to design incentives to make communities
more efficient in public good provision, rather than doing it itself.
One must not make a mistake of confusing the act of reducing the scope of
political power with reducing the scope of beneficial regulation and public
good provision. The argument presented here certainly does not advocate a
return to times when governments were small (measured by the size of their
revenues relative to GDP), as this is simply not feasible—the wheels of
history do not turn backward. A welfare state cannot and should not be
revoked just for the sake of keeping government size small. This is hardly the
point. Keep in mind, however, that even in times when governments were
small in scope and in size, such as the 19th century times of robber barons in
the United States, they still played an important role in granting monopoly
rights and licenses. A robber baron couldn’t amass his fortunes without
having (usually buying) the backing of political power. During the same
period, many European countries still had powerful states led by monarchs,
the proximity to which determined one’s riches.
Therefore, decreasing political power and the scope of activities handled
by national-level politicians does not mean reducing the power of beneficial
regulations, in itself a crucial public good. Providing the necessary public
goods like health care, education, roads and public infrastructure, public
safety, an independent legal system, maintaining cultural heritage, and
financial and corporate regulation that prevents monopolies and the
concentration of power, are and should remain the focus of governments. The
decisions in allocating these resources, however, should be given to local
communities where and whenever possible, while maintaining the credible
threat of punishment in case of transgressions.
For example, education spending, health care spending, spending on arts
and culture, local-level public safety, and local infrastructure projects are
good examples of public goods where the majority can be delivered by the
community and for the community. Running kindergartens, schools, and
hospitals should be under direct jurisdiction of a community, financed
directly by the taxes and donation allotments of people living in these
communities. Local public safety, services like the police or fire departments
should be under jurisdiction of communities where collective action
problems are easier to overcome. People living in a community with high
levels of social capital have strong incentives to have the best schools for
their children and the best health care for their elderly. Social capital on the
other hand is dependent on rebuilding interpersonal trust and trust in public
institutions, the key factors the First Lever is targeted to improve. Therefore,
shifting centralized power, reducing discretionary decision-making, and
introducing full transparency and accountability are all designed to build
trust in order to allow communities to deliver optimal social outcomes. The
other two Levers will explain exactly how empowered communities and
citizens can achieve this.
Some central government activities cannot be allocated to community-
level decision-making. Interstate transportation and power grids (gas,
electricity, water) are one example, science and higher education are another.
Also important are beneficial regulations like antitrust laws that prevent
concentration of corporate power and unfair market advantages for huge
corporations. There will therefore always be demand for centralized
governments, as we have no better system for collective preference
aggregation for specific types of public goods.
However, when turning to centralized government solutions we hope to
draw more efficiency simply by reducing the scope of activities and policy
complexity that public officials have to handle. Limiting them to providing
national-level public goods only and imposing strict rules under the credible
threat of being thrown out of office are best hopes of leveling their power
and reducing the impact and motivation for elite networks.
The same logic is applied to local government officials. Decentralization
does not imply granting more responsibilities to local governments, as this
would defeat the very purpose of lowering political power. As Chapter 6 has
shown, it is much easier to exploit political connections and engage in
corruption on a local level where there is lack of oversight and lack of
transparency. Local politicians, then, should be given the same institutional
rule-based constraints as national-level politicians. They should be granted
even less power as their role turns into a facilitator of community-level
decisions. They will be evaluated based on their operational merit, which is
key for local governments. Ideology plays little importance when solving
local issues, but operational prowess is crucial.
The reforms of the First Lever are obviously focused on politicians. But
they represent only the first part of elite networks. What about wealth
accumulation and the second part of the network—corporate bosses, the
20th-century nobility? Unjust wealth accumulation is and always was
generated and enabled through the political process. Throughout human
history, as detailed in Chapter 2, the oligarchy surrounding a leader would
benefit from the mere proximity to unhinged political power. The lesser the
scope of activities given to the politician, and the lesser the power of the
politician, the lesser the probability one exploits political power for private
gain.

10.2.6. Minor Reforms That Could Strengthen the First Lever

In addition to the aforementioned major structural reforms that would
establish an effective lever of reduced political power, there are several
minor reforms that could be introduced to additionally strengthen the First
Lever. However, this set of minor reforms would be applied on a case-by-
case basis rather than universally. Different countries have different
experiences and different electoral and political systems, so proposing an
encompassing electoral reform would be pointless. This section suggests a
framework within which to think about further electoral reforms that might
work better in some countries than in others. Such reforms would most likely
arise eventually through the democratic process once the Three Levers are
implemented. This is why they are, at this stage, considered to be marginal
improvements, but are nevertheless interesting to consider.
1. Introduce a 100% tax rate on campaign spending (direct campaign spending or PACs in the
United States) for all donations above a certain amount, e.g., $1,000 in the United States, €1,000
in the EU, etc. Any donation above hence needs to be doubled to account for the tax levy.

This reform would discourage large sums of money being spent in political
campaigns by large donors and big organizations. It would also lower the
amount of money in politics and turn funds away from glossy campaigns and
their well-oiled PR machines and shift it, in relative terms, toward true
grassroots movements that better represent opinions of concerned citizens.
The tax limit to the donation size should be at or above the mean monthly
salary in a country so as to encourage small donors who wish to support their
party or candidate.
There is obviously scope for misuse where one wealthy person can
donate more than, say, $1,000 by distributing it to his/her friends and family
members. Still, finding 10,000 people in order to make a $10,000,000
donation would be much more difficult to do. They are obviously free to
spend much more than $1,000, however that payment renders a 100% tax on
whatever they donate. Another scope of misuse is to funnel money
unofficially and illegally to candidates, an issue that is particularly
problematic in corrupt countries. Preventing this type of misuse would
require a powerful anticorruption watchdog that would compare the average
money spent in campaigns (by counting the costs of posters, events, TV and
other ads) to how much the candidate reported they have spent and received.
This would be an extension of the full transparency proposal. As for
corruption and bribes given directly to candidates for office, the very idea of
lowering political power and the scope of politically determined activities
has a goal of reducing the demand for political favors in the first place. It
does not eliminate political corruption, but it makes it less effective.
2. Lower informational asymmetry for lobbying by increasing transparency. The idea is similar to
the aforementioned full budgetary transparency where the public gets to see which pieces of
lobbying-funded research went into the decision-making process behind every newly enacted law
or regulation.

Most people have a misconception of how lobbying works. The public image
is that this is money been used to strongarm politicians into doing what the
lobbyists want, or money spent on various fundraising events. In reality, most
funds spent on lobbying are for salaries of the lobbyists themselves who
provide crucial pieces of information for legislators. They organize lunches,
dinners, and policy events where politicians and their staffers are invited to
hear what experts have to say on a certain issue. Money is also spent on
experts to deliver conclusions that someone in the industry welcomes. This is
not an act of an evil organization paying experts and scientists to lie, as it is
often perceived. It is simply a matter of finding the right experts who already
agree with the industry view and then paying them to help out and draft a
policy paper, or invite them on a panel to discuss a topic they are
comfortable with. No one is paid to lie. Bending statistics—sometimes.
 The point is that lobbying solves an informational asymmetry problem for
politicians. Legislators in parliament rely on either their staffers or, as we
have learned in the book, on their close network of friends for information.
Politicians are typically overworked in various committees, spend a lot of
time talking with voters or on media appearances, and spend an obscene
amount of time fundraising for the next election. They have little time left to
read long policy papers and make informed judgements, so they rely on their
staffers for this information (who get it from a variety of sources, the most
important of which are lobbyists), or directly on lobbyists through a variety
of events where they interact. Lobbyists are therefore rarely perceived—at
least by politicians—as unwelcomed salesmen pushing their agenda, but
rather as beneficial actors helping make better and more informed decisions.
Lowering their influence through bans is impossible. Their influence can
be lowered by lowering political power in general, but also by imposing full
transparency over the process through which they influence policymakers.
More precisely this would imply that every legislator, when making their
vote on a piece of legislation, should make public their entire decision-
making process: which policy papers they’ve used, which opinions they have
taken into account, and which ideas they have been exposed to. To a majority
of people this information would be irrelevant, but to a group that stands to
gain or lose a lot from a piece of legislation, knowing the process is crucial,
as they can use it to pressure a legislator to take into account arguments of
both sides before making the final decision. This would make the legislative
process much fairer and would expose how successful lobby groups actually
are in moving political decisions. Public scrutiny is the best remedy to
anything done in the shadows of government buildings or at invitation-only
gatherings.
Finally, many often advocated political reforms typically include
discouraging gerrymandering in order to make democracies more
representative, call for more prudent regulatory oversight bodies in many
different areas under government control, or propose to improve selection
into civil service, making it more apt to help politicians make the right
decisions that would favor the many not the few. While these are certainly
noteworthy efforts, all of which I would wholeheartedly support, I see them
as only marginal improvements over the current state of affairs where
political power is too high. Once political institutions are depersonalized,
and political power is reduced, such reforms will arise spontaneously from
the democratic process itself. That, at least, is the goal.
Lowering political power is closely connected to encouraging greater
civic engagement and participation among its citizens, operating through their
communities. To ensure this will happen, we need two more Levers.

10.3. Second Lever: Re-Empowering the Citizens

Engaging citizens is the most essential lever in activating the democratic
trial-and-error process. There is nothing more important than civic
engagement in holding politicians and public officials accountable. After all,
politicians are mere agents of the people in the principal–agent relationship.
The very root of the word “minister” implies an act of helping, taking care
of, or looking after people, not ruling over them. A prime minister is merely
the first among equals, also at the service of all citizens. Similar for the use
of the word “state secretary” (as used in US and UK public service), which
implies assistance and offering help. The very meaning of the words we
assign to the executive cabinet members means they are here to help people,
not rule over them. Voters hire politicians to do a job for them, and should
have many mechanisms at their disposal for punishing politicians. The
Second Lever defines some of these mechanisms.
The following set of proposals would work best in empowering citizens:
1. Paying gross salaries to people who can take control of their tax payments. Each citizen would
have a tax donation allotment through which they could choose who to donate directly. The goal
is to encourage citizens to directly participate and support what they stand for.
2. Introducing mandatory participatory budgeting for community public good provision, as a way of
extending and strengthening citizen participation.
3. Punishment referendums: giving citizens impeachment powers to directly punish transgressing
office-holders, introducing a credible threat against political power.

Let’s explain each of these with an emphasis on how they help in teaching
citizens about the real impact of direct democracy.

10.3.1. Give Citizens the Ability to Take Control of Their Tax Pay
ments
This reform proposal aims to encourage citizens to care about where their tax
money is going and how it is being spent. It is the first step toward increased
civic engagement. Paying out a gross salary, without automatically deducting
the income tax, and then encouraging them to distribute a part of that salary
equivalent to their tax payment might sound revolutionary, but if implemented
it could lead to several positive outcomes. First, it will help perpetuate the
perception that tax revenues are not the government’s money that can be spent
as those in power desire. It is the peoples’ money and they have the right to
say where and how it should be spent. Second, having people engaged
directly in how they want their money being spent will certainly increase the
levels of civic participation and help people understand their own rights with
respect to their governments. Finally, having the choice to directly support
what they stand for will make sure the money is really going to where it is
most needed—to health care, education, safety, infrastructure, charity, or
various civil society groups. It is direct representation at its finest.
Having said that, such a reform might be difficult to introduce and
implement. An often-cited reason against it is that people will be late or
otherwise negligent with their payments. That argument is baseless given that
people are obliged to regularly make payments on their bills and various
other communal services or local taxes. These are not taken automatically,
but are billed and paid later. Not paying your bills means losing the service.
Not paying your taxes means jail time and big fines. People will certainly
have a motivation to pay their income taxes on time, every month, just like
they pay all their other bills. It should be noted here that pension, health, and
unemployment contributions could still be deducted automatically, as these
represent individualized insurance policies that people benefit from when the
event occurs, i.e., when a person gets sick, losses a job, or retires. This
proposal is thus limited to the ability to have control over income tax
payments, to have the power to decide where they should be spent.
How exactly would it work? Each person receives their monthly salary
from which income taxes are usually automatically deducted, or has to pay
their income taxes at the end of a fiscal year (in case of self-employed,
rentiers, business owners, etc.), with practices varying from country to
country. When those payments are to be made, either personally or via the
employer, each individual is given the right to choose from a list of
government programs or institutions they consider more important to them,
locally or nationally. They are hence given a tax donation allotment that they
may choose how to distribute. This is done online or through a government
app, where people sign-in via their social security numbers and unique codes
given on each pay slip or each tax return they have to file. Within the app they
first start with a choice between most general sectors (e.g., health, education,
defense, transport, housing, etc.), and after making their initial choices they
go into greater detail and award the specific programs within each major
program. This needs to be very user-friendly and almost gamified to attract
users, making the process simple and straightforward to use while still
delivering the empowerment effect.
However, a large part of every national budget is more or less fixed,
given that social security contributions are directly used to fund the pension
system or health care programs and are often not enough to bear the entire
burden, so revenues from other sources have to be used to fill up the gap.
This would imply that every individual could only choose a part of their tax
donation allotment (say, 50%) to distribute as they please, or could, for
example, be asked to choose at least N out of M (where 2N≤M) institutions
or programs listed from each main sector. When designing this the focus is
always on simplicity, the process cannot become too complex for an average
citizen to use.
Furthermore, a part of their tax payment can also be allocated to civil
society or charity organizations, or as mentioned under the First Lever, to
support local or national media that uncovers political or corporate scandals.
For example, 5% or 10% of each person’s tax allotment can go toward
supporting these groups, which would reduce their dependence on
government money and orient them toward their core work—doing charity
and raising awareness on important issues. It would introduce incentives for
these organizations to become even better at their jobs, where they could
attract even more money from engaged citizens who divert part of tax
revenues directly to these organizations. A more lenient approach would be
to introduce tax deductions for individual donations to charity, media, or
civil society groups, similar to the tax deduction incentive firms have to
donate money. This system could also be set up online, in the exact same way
as the tax allotment process—simple, approachable, and gamified.
One question that obviously arises here is, how can we make sure that
taxpayer money actually goes to where the people want it to go? Given that
the allotment decisions are to be made online, we could use a form of
blockchain to record all transactions and see exactly where they end up, i.e.,
at which public institution. A blockchain is by definition resistant to altering
its data entries, as data in a single block cannot be modified without changing
all the subsequent blocks on the entire decentralized network. It also makes it
possible for anyone to monitor where the money is going and how is it being
spent. It therefore strengthens the full transparency proposal of the First
Lever, particularly if both of these are to be implemented simultaneously,
thus significantly improving trust in the system, and making sure that citizens’
desires are respected. Individual tax allotments will, of course, be
anonymized to protect privacy of people’s income statements.
There are obviously drawbacks. People might not have the time or the
inclination to determine who they send their tax allotments to and would
prefer to leave it to someone else, presumably the government. This option
will remain a possibility. A person that does not wish to individually
determine where their tax money should go is free to opt out and state
specifically (within the online app) that he or she has no intention of
determining the allocation. This decision can always be reversed, by asking
the government to grant back the right if requested. This way people are
always given a choice and a possibility to participate more directly in the
allocation process.
Furthermore, there is an issue of some important services being
overlooked and defunded if people do not consider them worthy or if they
simply begin to favor some services over others. For example, it is safe to
assume the majority will prefer more money going to health care and
education, and less toward relatively unknown regulatory agencies, or to the
public administration which has a role that is difficult to measure or value.
This is why only a part of the budget is to be allocated through direct citizen
engagement. Income tax revenues for OECD countries are on average 24% of
all budget revenues, social security contributions (health and pension
insurance) about 26% of revenues, and VAT revenues about 30%. The United
States, not having VAT, is a slight outlier here as the share of income tax
revenues in the federal budget is at 50%, while social contributions in the
form of payroll taxes are 36%. However, on a state level in the United
States, sales and property taxes contribute more than income taxes.
Therefore, even though income tax revenues can be a significant contributor
to the budget, if only a part of them (say, half) is allocated directly, this need
not at all impede important yet overlooked public services, and it can still
deliver the crucial incentive to kick-start greater citizen engagement over the
allocation of and control over taxpayer money.
 Having all this in mind, this type of proposal is a game-changer and
should be introduced gradually. The best way is to start on a local level,
rather than national, to help people get used to the idea, to familiarize
themselves with the budget allocation process and how to choose optimal
projects. Call it a beta version of the reform. They thus choose only between
various local projects and how they want their local tax allotments
distributed. The second reform proposal, budgetary participation, builds on
this idea and starts locally, focusing on the allocation of funds for important
community-level projects (decisions on what to build, what to fix, etc.) As
people gradually increase their civic engagement on a local level, we can
expect the same desires to be translated to the national level. It may be a bit
more complicated as national-level governments handle much more duties
and responsibilities than local level governments, but some form of direct
citizen participation in the public good allocation process must be made
available.
Finally, an important immediate consequence of such a reform (the first-
order effect), is to make an even bigger part of the budget nondiscretionary
and fixed, so that public officials are forced to allocate resources per the
citizens’ wishes. This further reduces the scope for government inefficiency
or corruption and strengthens the full transparency proposal of the First
Lever.

10.3.2. Mandatory Participatory Budgeting for Community Public

Good Provision
This reform proposal is merely a continuation of the previous one, with the
idea of strengthening and reinforcing it, particularly if applied gradually,
starting with community-level participation. The burden once again falls on
technology to enable people to directly express which public goods they
wish to be provided. Using the exact same process as described above—an
online app where people sign in with their unique information—we can
introduce direct democracy on a community level where people can choose
to allocate public goods that immediately help their well-being.
This proposal is nothing new and is already being implemented in a
number of cities around the world. It has proven to be particularly efficient at
the local level of government, although it does require a learning curve for
the citizens to get accustomed to using the feature.
 Once they get accustomed to directly participating in the creation of their
budgets, they get acquainted with the process and play a very active role in
their community development. Some people are obviously more active than
others, but the very idea of something like this existing significantly improves
trust among all actors. It also educates the citizens of the standard economic
concepts of opportunity cost and scarcity. Budgets are limited and only so
many projects can be handled at a given time. Also, financing one big project
means less money available for a number of smaller ones, and vice versa.
The implementation is even more straightforward than the previous
proposal. Citizens get a simple survey accessible through an online app
where they are offered a set of projects they may rank according to
importance, thus choosing which projects are to be funded. For example, for
the upcoming fiscal year a set of N projects of roughly equal size and cost
are given, where citizens have to choose at least 2. This can be done in
groups of projects; for example, 5 expensive projects, from which 2 are
chosen, 10 medium-priced projects from which 4 are chosen, and 20 low-
cost projects from which 8 are chosen. People will have to choose between a
set of minor projects such as whether to fix a road pothole, a streetlight, or
broken benches in the public park, or will face a choice between larger-scale
projects, such as a new town swimming pool, a new local sports stadium, or
a new power plant.
The vote would use the Borda count approach, where citizens assign
points to each project expressing the strength of their preference. For
example, for 5 given projects, each citizen distributes from 1 to 5 points,
where 5 points are given to the most preferred, and 1 point to the least
preferred. When the points are summed up the two projects with the highest
score get funded. A Borda count approach of allocating preferences is
chosen as it has the highest probability of delivering a Condorcet winner12 in
a pool of multiple choices.
To administer, each household is given a letter (or email) alongside its
bill for communal services or local taxes, where the rules are clearly
specified and each household is given a unique code to use while submitting
their votes. The letter tracks the size of each household where bigger
households get a higher weight, i.e., a higher value of each individual vote.
People can then choose how to express their preferences: this can be done
immediately on the letter they receive which is then mailed by post (by
assumption elderly citizens will most likely vote in this fashion), via logging
into a web app where people use their unique code, or directly from their
phones by scanning the QR codes from the letter/email. Anonymity and
protection of privacy must be guaranteed, which is easy to implement from a
technical standpoint.13 Just like with the previous proposal, people who wish
to opt out are free to do so.
Having direct democracy this way might not always result in projects that
are socially optimal. Which is why, for example, health care or education
spending could be handled separately. The choice should not be between a
new school or a town swimming pool, but how to distribute the within-health
and within-education budgets: what to prioritize and why.
Nevertheless, even this might not deliver the most socially optimal policy,
which brings us back to the democratic trial-and-error process. Even if, at
first, projects are chosen that do not deliver the greatest value to the
community, in the second or third trial, these errors will be fixed. The
community will eventually converge toward an optimal social equilibrium
and deliver the necessary public goods. The whole point is not having a
central authority force a project onto a community. It should be left to the
citizens themselves to decide. Even if they sometimes make wrong decisions.
Wrong decisions are useful as they can help citizens see the errors they’ve
made and correct them. On a community level, errors are very easy to spot.
The main goal of this proposal is to offer citizens an option to choose
exactly the type of projects they want, thus respecting their will and creating
a positive and true perception that citizens do actually have control over
budgetary redistribution. This is another example of an irreversible reform.
Once citizens get used to having direct participation and control over
budgets, it becomes very difficult to regress to the old way of nontransparent,
nonaccountable, and discretionary decision-making local governments.

10.3.3. Granting Impeachment Powers to the Citizens for Direct P

unishment of Officials
Ancient Athenians used an effective method of controlling political power
called ostracizing. Each year the citizens of Athens with a right to vote
(adult men only; women, slaves, and foreigners living in the city were not
allowed to vote) could nominate one citizen who they assumed was
becoming too powerful or too dangerous and vote to exile him from the city
for 10 years. Each citizen would engrave a name on a piece of pottery
(ostrakon), the names would be counted by the highest officials, and the
person with the most votes would get exiled (ostracized), but would not lose
his citizenship or his property in the city. They could come back after 10
years and resume participating in public life. Even though this was a well-
established institutional rule, the citizens of Athens seldom used this power.
Over the course of the rule being in place (it is believed it was only used in
the 5th century BC), less than 15 people in total were ever ostracized,
meaning that their transgressions must have been significant to deserve such
an outcome. This could have been done to any citizen of Athens, not just the
governing politicians, anyone who was thought to be a threat to democracy.
Reintroducing the same rule today would be impossible. For one, it is an
infringement of basic human rights, something that ancient Athenians did not
possess as an institutional safeguard. It is easy to imagine governments,
especially anocratic or dictatorial regimes, using propaganda to punish a
scapegoat, or prosecuting their political opponents (or within-party threats)
and hence eliminating them as competition (dictators and wannabe-dictators
already do this, without the institution of ostracism or having to ask the
people what they think). Second, the legal system is designed to punish
transgressions of all kinds. It is complex and often slow for a good reason; to
avoid manipulation and ensure just outcomes.14 Punishment for breaking the
law is not a power bestowed on the masses, and for a good reason—it can
quickly and easily turn into mob rule.
However, having elections every four years as the only method for
citizens to enact punishment against power holders is clearly not enough.
Elections rarely act as a referendum on government performance during the
previous four years. First of all, voters are myopic and only take into account
what happened a few months before the election, meaning that the
government is held accountable only for things that happened recently.
Second, in many high-corruption countries, governments engage in clientelist
practices and buy votes, usually through local power brokers (as shown in C
hapter 6). Third, elections offer a number of choices, where people typically
choose the least bad option (“the lesser of two evils”), and may be stuck with
a bad government simply because the alternatives are even worse.
Elections therefore lack the necessary credible threat against political
power, especially if politicians operate within powerful small winning
coalitions. Citizens need an additional constitutional force which they may
use in between elections to remove individuals they see as unfit or too
powerful for their position. I propose an option to hold a punishment
referendum against any in-power elected official where people may vote
directly, via a referendum, to punish the official outside of regular elections.
The punishment is enacted in the form a ban against running for public office
again.
Think of this as the power of impeachment given to the people, instead of
the Parliament. Parliaments in every country have the power of calling a vote
of no confidence against a government or any single government official. But
if the party in power holds an absolute majority in Parliament, it is difficult,
if not impossible, to successfully enact this punishment. Giving impeachment
powers directly to the people via referendums is a compelling credible threat
that acts as a constraint against any transgression of power. Elections are few
and far between. Citizens need to be able to hold officials accountable more
often.
A punishment referendum can be a compelling deterrent against
politicians, so we need strong institutional safeguards and rules to prevent
potential abuse. First, voting needs to follow the same rules as any other
referendum. In order to call it, at least 10% of registered voters need to
organize a petition. The vote does not have to be an annual event as it was in
Athens, it can only be triggered if there is enough will from the people to
hold it. Second, at least 50% of registered voters need to turn out to make the
results binding. Third, a punishment referendum can be called for a single
person, or as a vote on up to five individuals. This depends on the petition
demanding the referendum. If there is only one person on the ballot, he or she
is punished with at least 50% plus one vote. If there is more than one person,
then the person with the most votes gets punished. Fourth, the referendum can
only be held against those holding office, executive, legislative, or judicial. It
cannot be applied against any citizen or against opposition politicians, only
those who need a constraint over their position of power. Fifth, there can be
only one punishment referendum in a single year, and there should be at least
12 months between the two processes. This is to prevent procedural abuse.
Finally, the punishment implied by the referendum needs to be strictly
imposed and defined constitutionally. The proposal is to ban the person from
running from public office again.
The point of having such a rule is to give citizens an option of a credible
threat against those holding power. Like nuclear games of deterrence, the
threat of retaliation prevents the other side from using their attack. In a
standard Nash equilibrium,15 it is hard to expect that citizens will use their
credible threat too often, but it delivers an important signal to any dishonest
politician who wishes to engage in corruption, or to any politician with
autocratic or dictatorial tendencies that the punishment for such transgression
can be severe. The idea is to make public officials afraid of the people, to
turn them into true public servants, and thus change incentives for entry into
politics to include only honest and morally incorruptible individuals. Very
often losing elections is not enough of a credible threat, because winning
elections requires forming a minimum winning coalition of interests to keep a
person or group of people in power. These referendums merely add another
dimension of political accountability and control, and grant a powerful
credible threat in the hands of the people.

10.4. Third Lever: Re-Empowering the Community

Why emphasize the community? What makes it so important in improving
people’s trust in each other and their trust in public institutions? According to
a number sociological and economic research studies, the community
delivers great value to its members. It offers them meaning through
participation in various local organizations and associations like parent-
teacher associations, school boards, neighborhood oversights, religious
groups, volunteer fire departments, charity organizations, community events
and gatherings, and the like. The community anchors individuals, gives them
a sense of control and self-determination, and provides an opportunity to
directly engage in public good provision, thus encouraging them to make a
difference in the communities they care about. Research has found that
growing up in better communities carries a significant impact on a child’s
economic and social outcomes later in life (such as college attendance and
earnings).16 Most importantly a healthy and vibrant community is a crucial
characteristic of a well-functioning democracy.
Local communities can also be much better at solving the collective
action or common pool resource problem. Through continued cooperative
behavior they can successfully internalize externalities and discourage free
riders. This was best proven by Elinor Ostrom’s Nobel prize–winning work
using the cases of local fisheries, groundwater basins, and irrigation systems.
17 A community offers full transparency and decentralized decision-making
where every member sees how much another member is contributing.
Members encourage and help each other while building strong social capital
and interpersonal trust. In such environments the incentives for free riding are
extremely low, meaning that collective action is achievable and can be quite
efficient. This is true for any close-knit community, whether defined
geographically or through common interest.
In his book The Third Pillar, Raghuram Rajan delivers a persuasive
argument on the importance of the community in breaking up concentration of
political and economic power. Rajan stresses several positive roles of a
community. It teaches younger individuals how to internalize community
norms and values, how to promote community interest before self-interest,
and it even supports education for its members. It helps build binding social
relationships where neighbors help each other in time of distress and can
even act as lenders of last resort.18 Finally, communities encourage favors
and resolve conflicts and disputes between members, which reduces the
necessity for the legal system to intervene. A community therefore reduces
the need for both judges and regulators.19 It does not eliminate either (nor
should it), but it reduces the demand for both, making them more efficient and
less costly. Rajan, however, also finds that in the persistent battle between
states and markets, between protectionism and globalization, it is the
community—dubbed the third pillar of this delicate balance—that has been
in persistent decline; social, economic, and political.20
Among the first to notice this trend in the United States was Robert
Putnam in his seminal book Bowling Alone, where he details how Americans
are becoming increasingly detached from their communities. He paints a
bleak picture of American society where social capital has steadily been
depleting ever since the 1960s. Civic engagement—illustrated through a
decline of league bowling even though individual bowling has increased, and
measured directly through membership in various organizations like religious
groups, labor unions, parent-teacher associations, veteran organizations, and
of course political engagement—has been in persistent decline.21
One consequence of this is depleted democratic capital, which limits the
power of democracy’s trial and error mechanism. But an even more
important consequence might be something that was documented in Case and
Deaton’s book Deaths of Despair: middle-aged non-Hispanic whites in the
United States, lacking a college education and typically living in remote rural
areas, are increasingly dying from despair-related incidences: suicide,
opioid abuse, and alcohol poisoning.22 Community disengagement, along
with failing US health care, are major reasons behind such adverse social
outcomes hitting a large fraction of Americans.
The lower educated white working class has faced particularly hard times
over the past 20 years, not just in the United States but across the developed
OECD economies. Well-paid manufacturing jobs being replaced by lower-
paid service jobs offering much lower job security was the key economic
consequence of technological progress and globalization in the developed
West. These trends carry remarkable resemblance to the postcommunist
transitions in eastern Europe23 in the 1990s. The less educated working
class, living mostly in rural areas, lost their jobs in traditional industries,
became long-term unemployed or were faced with lower-paid service jobs,
and saw greater instances of depression, anxiety, and social apathy. As a
consequence, the political spectrum in eastern Europe switched completely:
losers of transition—lower educated working classes with low incomes,
higher instances of unemployment, and living closer to the poverty line
started voting for right-wing parties, whereas the winners of transition, living
in low unemployment areas, with higher incomes and greater opportunities
(the new bourgeoisie) started voting for left-wing parties.24
This sounds very familiar to the contemporary political landscape of
many Western democracies, the United States and United Kingdom in
particular. Low-income working-class voters are turning to the Right,
whereas high-income upper-class voters are voting for the Left. The working
classes in particular are feeling detached from the society’s elites. They
distrust them, as much as they distrust politicians in general, and blame them
for negative social outcomes and their own failures.25 Nothing showcases
this better than the reactions of our societies to the COVID-19 pandemic. In
the United States and across many European countries the pandemic has been
remarkably politicized. Societies are so divisive that even a natural
occurrence like a virus is used to sow political divisions and spread
conspiracy theories. Distrust against science and experts mirrored the
distrust against governments and society’s elites, making the pandemic seem
as yet another deliberate failure of establishment elites. The anger and
anxiety felt by voters searching for antiestablishment candidates (like Trump)
or antiestablishment outcomes (like Brexit) is fueling even greater discord
and throwing citizens into echo chambers (social bubbles) where it is
becoming increasingly difficult to understand a person you disagree with
politically. The social media is perpetuating such echo chambers by serving
us only the information we agree with, thus further insulating us from other
peoples’ experiences.
Evidence of this can be seen in Figure 10.1, which shows the map of the
2020 US election results between Biden (blue) and Trump (red) by county,
where each county is visualized according to its population size. Notice the
immense urban–rural political divide. In traditional Red States, where Trump
won easily, counties with denser urban populations voted Biden (e.g.,
Houston, Dallas, Austin, and San Antonio in Texas, New Orleans in
Louisiana, Nashville and Memphis in Tennessee, etc.) In traditional Blue
States, where Biden won easily (like New York, California, Illinois, or
Washington), the large urban areas all voted for Biden, but the small rural
areas all voted for Trump. This pattern is strong across the country, and is a
testament to the urban–rural political divide in US politics that has been
present for the past few decades.
The striking thing about this divide is how it emphasizes geographical
echo chambers. Case and Deaton’s deaths of despair are most frequent
among middle-aged low-educated whites typically living in rural areas.
Their voting patterns suggest they are looking for a way out, and populism is
a particularly attractive remedy. But as they get increasingly detached from
urban voters—and vice versa, as urban voters get detached from rural
experiences—we are left with a deeply divided country, both parts of which
are wrapped in their own bubbles, now even geographically completely
detached from each other. Add to this the different news sources used by
different communities and the bubbles become obvious. No wonder that US
political polarization as measured by Congress voting patterns is at an all-
time high.26
Figure 10.1 Map of 2020 US election results by county. Red circles are counties won by Trump (Rep),
blue circles are counties won by Biden (Dem). The size of a circle depicts the population size of the
county. Source: New York Times, https://www.nytimes.com/interactive/2020/11/03/us/elections/results-p
resident.html.

However, unlike their urban bubble counterparts, the rural bubble

inhabitants are increasingly living in dysfunctional communities
characterized by higher levels of distrust, higher levels of social apathy, and
in general a zero-sum mentality. This makes them easily swayed by zero-sum
populism, not just in the United States but across Europe as well.
Spotting a dysfunctional community is easy. It is typically a place with
higher levels of crime (theft, murder, rape), poor public services, corruption,
and perverse incentives that propagate the self-defeating negative social
cycle. As Case and Deaton pointed out, these are also places with higher
instances of middle-aged white deaths related to drug overdose, alcohol
poisoning, and suicide. Such communities carry a strong distrust against the
state and are in general bad or depressing places to live in. However, despite
their distrust of governments and poor public services there is still a greater
demand for government intervention. As Rajan27 puts it:
 The faint hope that the government will dig a latrine, pave a road, or discipline school teachers can
prevent the local population from organizing to do so. In frontier towns in the United States, the
community raised a barn or built a road itself knowing there was no one else who would do it. In
dysfunctional communities where the government is closer, the misplaced expectation that the
ghost of the inefficient government will eventually appear and do the job crowds out what little
private incentive there is.

This finding has been shown to be true on a cross-national level as well: in

countries with lower levels of social capital—approximated by
interpersonal trust—people support more government intervention in the
economy.28 In other words, even when people know their governments are
corrupt and inefficient, they still prefer greater regulation and government
intervention, simply because they don’t trust private incentives or community
engagement to provide solutions. This makes sense if one thinks about the
interrelation of a country’s formal and informal institutions. If formal
institutions are weak and inefficient, meaning that if the rules in society are
poorly defined and offer too much scope for corruption and perverse
incentives, then informal institutions will adjust accordingly and this will
affect the accumulation of social capital (people start losing trust in the
system and each other). The relationship works in both ways; if the “rules of
the game” are defined to be inclusive, then the accumulation of democratic
capital will eventually lead to a change in customs, norms, and trust in a
society (i.e., our informal institutions).
Moving this down to a community level, in functional communities that
deliver the right incentives for their members, people invest heavily in their
social capital. This rewards them through greater incentives for cooperation,
reduces the necessity for greater regulation, while government intervention is
limited to providing the key public goods that the community desires. In
dysfunctional communities, reverse forces are in play. People fail to invest in
social capital, they shun cooperation with their neighbors and demand greater
regulation. Trust is extremely low as are economic opportunities. The local
government is likely to be corrupt and public good provision subpar.
In such communities or societies not even supranational authority can be
too helpful as it creates the same dependency and the same crowding out
effect. A good example here is the relationship between the European Union
and its more corrupt Member States. The EU has no credible threat of
punishing corruption in its Member States. It does extend pressure on
candidate countries to lower corruption and increase institutional safeguards,
but once a country becomes a member, the EU has little power to prevent
corruption and kleptocratic practices of a country’s political class.29 It
continues, however, diverting resources to infrastructure projects in many of
its more corrupt Member States (under undoubtedly noble goals of fostering
development), only to see a large chuck of such projects get red flagged for
procurement corruption.30 The EU’s institutional bodies that are given the
task to prevent corruption (like the European Anti-Fraud Office, OLAF) are
relying on each Member State’s domestic institutions to aid them in their
investigations, which they obviously fail to do if such institutions are
themselves locally politically captured. Corruption goes unpunished,
infrastructural projects funded by EU money get overpaid, while local
politicians use the excess funds to divide them between themselves and their
cronies (rewarding their winning coalitions), thus strengthening their local
rule, much to the dissatisfaction of their societies. The negative vicious cycle
keeps spinning as greater government inefficiency and corruption increase
social apathy and discourage civic and political engagements, trapping
voters in the same social echo chambers as we have seen in the United
States. It is getting increasingly difficult to break up dysfunctional
communities, even in developed societies.

10.4.1. Decentralize and Depersonalize Decision-Making over All

ocation of Public Funds
How do we prevent a community falling into the vicious cycle? Or even
more importantly how do we pull dysfunctional communities out of their
abyss in order to ensure that delivering more power to community-level
decision-making will actually take effect? As emphasized earlier, rebuilding
social trust is such communities is the key to kick-start the democratic trial-
and-error mechanism. This is becoming the number one priority in
rejuvenating communities and in the long run lowering incentives for power
accumulation.
Where to start? Community re-empowerment is a natural extension of the
first two levers and is rooted in the idea of delivering more decision-making
power to community self-government, down to a neighborhood level. The
point is to have decisions decentralized and depersonalized, meaning that
allocation over public goods should not be contingent on individual power,
but on collective power. When more power is given to communities, this
helps them in their economic reinvigoration by attracting more individuals to
live there, and sets the stage for the rise of dynamism and innovation.
It is important to emphasize that this does not mean simply relocating
power, taking it away from national-level politicians only to give it to local-
level politicians. That amounts to nothing as local-level politics most often
exists in the shadows, away from media attention, and deprived of any
accountability. The idea is to give more decision-making power to the
community itself, not its representatives or its local leaders. The local
government needs to only be a service for the community, to provide the
public goods that the community needs, and that it collectively enforces.
Being the leader of a community cannot be a function that allows any
discretionary spending decisions given to the leader. On the contrary, all
spending and redistribution decisions need to be handled by the community
itself, where everyone participates, whether it is a street, a neighborhood, a
small town, or a village. Size is key here, as the smaller the community, the
more likely it will be able to solve the collective action problem in line with
Elinor Ostrom’s common-pool solution. Power is in the hands of a small and
easily accountable collective, not the individual.
What would this look like? Imagine a neighborhood where all local issues
—decisions on where to build a road; fix a street lamp; build a park; build a
new kindergarten, school, or small hospital; organize an event; or grant a
building license for a new house, apartment complex, business, or other
major investment—are decided solely by people living in that neighborhood.
Neighborhoods don’t have large budgets, nor should they. But they have the
people’s decisions on where to place their tax money (Second Lever), and
they have the power to order the city officials (or higher government officials
in case of bigger infrastructural projects) to build them what they voted for
via participatory budgeting (again, Second Lever).
As explained under the Second Lever, budgets are limited, and voters
would not always get what they want, but they would have choices over
which projects are of higher priority for their community. Each community
would get assigned a fixed amount (proportional to its size and tax
contributions) not to spend it themselves, but to decide how to spend it, on
which projects. The community does not handle any funds. It only
participates in decision-making over the allocation of such funds.
All decisions coming from local communities—villages, streets,
neighborhoods, no matter how they’re organized—are binding by law, and
higher-level officials have an obligation to fulfill them. Higher-level
officials are thus nothing more than executors of the people’s will. They have
no power over what gets built on a local level. They don’t even pick the
contractor. Their only job is operational: to administer the decision, write up
the public tender, conduct it, make payments, and make sure the legal and
regulatory requirements are respected. As described under the First Lever,
governments, whether national or local, truly become servants to the people.
They still maintain the rule of law, the justice system, and all necessary
public services, but the people have a much greater say over how funding is
allocated, including for things like wages of public sector servants.
This would imply that, for example, teachers’ unions no longer bargain
over wages with governments for the entire country. Wages of school or
kindergarten teachers, doctors in public hospitals, police officers or fireman,
local judges, or local public sector employees are negotiated within each
community directly. The people decide who they value more. Communities
will soon come to realize the laws of supply and demand governing such
wages. If there is no good doctor or teacher in a community, they might want
to attract one by offering higher salaries. If the public office doesn’t attract
good enough candidates, wages in the public sector need to be increased.
Only wages of public sector employees on a national level (people
working in ministries or national-level authorities like the central bank,
regulatory agencies, etc.) are decided on more centralized levels, which is
where employees are free to join institutional-level unions if they require
greater bargaining power. Universities, for example, can function as their
own community. Many, in fact, already do. One more level is to hand them
decisions over the allocation of all public goods in their community, while
maintaining the provision that members do not have direct access or the
ability to spend these funds, just the power to make the allocation decision.
Empowering the communities this way might seem like a radical change.
This depends on how one looks at it. A re-empowered community does not
imply a return to tribal societies where the nation-state is constrained and
impotent. Its point is to engage citizens into local-level allocation decisions
over public goods, where they can actually make a difference in their
community. It does not imply that central governments should stop offering
their key public services (like public safety, health care, education,
infrastructure, defense), but it does imply that the provision of such services
will be considered much fairer and more representative of what the voters
really want. This is far from radical; it is democracy at its finest.
One thing that might discourage decentralization of power and community-
level decision-making is the geographical clustering of capital and powerful
people in big cities. Figure 1.2 in Chapter 1 shows this—the majority of
wealth and power are created and maintained in a few locations in each
country. The network effect is strongest in such areas, due to the mere
proximity between politicians, corporate executives, and other powerful
individuals. A full decentralization and disruption of elite networks would
imply dissolving such clusters and discouraging the network homophily
effect in order to prevent clustering of corporate and political power. It
would basically imply that we force the most powerful companies,
individuals, and politicians to be randomly scattered across the country in
order to reduce their exposure to each other and make them more focused on
developing the local community they find themselves in.
This, however, is impossible to achieve as it defies the laws of physics
when it comes to how networks behave (recall the examples from Chapters 4
and 5), not to mention that it is woefully unconstitutional and illiberal.
People have every right to choose where they live. While a few wealthy
individuals do relocate, the main clusters are still formed in places like
Washington, DC; Silicon Valley; or Manhattan in the United States (and its
close proximity, like business owners living in Connecticut, or Silicon Valley
“tech bros” living in San Francisco); London, Brussels, Berlin, or Paris in
Europe; Hong Kong, Singapore, or Shanghai in East Asia; Dubai and Doha in
the Middle East, etc., or are perpetuated in places like Davos. Washington,
DC, is a good example of the network clustering effect—the capital became
the headquarters of all major interest groups and lobby organizations, and all
individuals working in or around politics. The huge US political industry is
condensed in DC, so much so that the city itself underwent remarkable
gentrification due to a lot of wealthier individuals working in the industry
starting to move into the city (rather than its suburbs), thus completely
rejuvenating once high-crime neighborhoods.
One consequence of the COVID-19 pandemic—very possibly another
critical juncture in human history—that could help increase community
empowerment and possibly lower the clustering effect in big cities, is the
trend to work from home. People from big cities, working from home, were
increasingly moving to smaller towns during the lockdowns. A good sign of
this was the rise of room lettings in smaller communities around big cities,
and a significant decline of room lettings within big cities during lockdowns
across the United States and many European countries. After the pandemic
ended, however, life in big cities was quickly restored, as they still offer a
multitude of benefits, but some fraction of individuals might choose to stay
living in smaller communities, working remotely. Some companies are
already encouraging this, which is lowering their fixed costs. Some are even
considering offering monetary incentives to their employees to move to other
places. Think of the potential this can bring to rural areas and small towns.
They could flourish as individuals with higher incomes drive greater demand
for goods and services in such communities. Working remotely outside the
big city furthermore lowers commuting time and helps save the environment
by reducing emissions. The majority will probably not choose to do so, but it
doesn’t take a lot of people to start changing local communities.
Finally, clustering in big cities around nodes of power does not imply that
decision-making over public good allocation in such cities cannot be
organized on a neighborhood or street level. The units will be smaller, but
the collective action solution is the same. As for powerful individuals which
form clusters around themselves, their limit to power is contingent on the
limit of power of politicians, the First Lever, but also by decentralization of
decision-making. If a corporation wishes to build a factory or a plant in a
community, it needs to get approval from all its members, not from a single
politician who they might be tempted to bribe or donate to their campaign. It
will be much more difficult to foster a negative impact on a community (in
terms of negative externalities from pollution for example), when decision-
making power is decentralized. Depersonalization and decentralization are
thus crucial in order for community re-empowerment to work. They are
crucial for democracies to deliver its greatest benefit.

10.5. Second- and Third-Order Effects of the Three Levers

The proposals under each lever are all designed with second- and third-
order effects in mind, and they are all conceptualized to support and
reinforce each other. What, therefore, can we expect after gradually
implementing each? Which societal changes are most likely to occur?
The first desired long-term effect of the Three Levers is to increase both
interpersonal trust and trust in public institutions. In the gradual process of
achieving this effect, incentives for elite network creation should be reduced,
and hence inequality is expected to decline. All this is supposed to be
achieved by a combination of lowering political power, depersonalizing
government institutions, increasing accountability and transparency,
improving selection into politics, and diverting more centralized decision-
making over public good allocation to local communities. This is obviously
easier said than done and depends on a gradual implementation process that
slowly integrates second- and third-order effects. There is no easy and quick
path to dismantling elite networks.
Having the citizens participate and enact more control and accountability
over its public institutions is a process that needs to be learned and adjusted
to within a democratic setting. It will take time before the implementation of
each reform proposal encourages more citizens to actively engage by
monitoring politicians and bureaucrats and discouraging them from trying to
embezzle public funds. It will take time before citizens get used to directly
allocating their tax allotments and choosing local public goods directly. And
it will obviously take time before institutions get depersonalized, and
centralization of power is reduced from national and local politics.
After this first-order effect is achieved, the second-order effect is to
expect office-holders to start being more careful and accountable. After
making an even bigger part of the budget nondiscretionary and fixed, public
officials are forced to allocate more resources per the citizens’ wishes. This
further reduces the scope for government inefficiency or corruption and
strengthens the full transparency proposal of the First Lever. The very idea of
granting more power to citizens in the allocation process and controlling this
allocation through an online decentralized mechanism further increases
transparency and discourages incentives for cheating, fraud, and political
discretion. Greater citizen participation also encourages free media, while
free media encourages citizen participation. Their combined strength ensures
that politicians and corporations are called to greater scrutiny and held
accountable, while rebuilding trust in public institutions and among each
other. Add to all this the credible threat of citizens being able to severely
punish office-holding transgressors, and incentives for entering politics are
immediately different.
When there is little room for embezzlement and corruption, when their
power is severely limited to the role of true public servants, dishonest
power-hungry individuals have less incentive to participate. They shift
selection into politics to a pool of honest individuals with a sense of public
duty who can truly perform the role of public servants (by being benevolent
leaders and executors of people’s will) instead of current dissolute rulers.
Similarly, less centralized decision-making for politicians lowers incentives
for corporate bosses to form elite networks to influence politicians, as the
costs of doing so significantly outweigh the benefits. If being in close
proximity to an office-holding politician does not help you get a favorable
decision from a government, given that such a decision depends on
institutional processes and not individual will, there is no incentive to form
strong elite networks that help skew incomes of top executives. Over time
inequality should thus go down. These are the desired third-order effects. Ta
ble 10.1 summarizes the full mechanism and expected long-term effects.

Table 10.1 Long-term effects of the reforms proposed under the Three Levers
Reforms First-order effects Second-order Third-order
effects effects
Lever 1: – Full transparency– Greater transparency– Greater civic – Improved trust and
Reduce – Free media and accountability engagement greater democratic
political power
– Term limits – Better use of – Discouraging capital
– Rules instead of technology to prevent dishonest – Better selection into
discretion corruption politicians politics
– Reduce scope of– Rule-based politics – Turning politicians– Lower incentives
centralized into public servants for elite network
activities – Depersonalization formation
Lever 2: – Tax allotment to– Greater citizen control of governing – Lower inequality
Empower citizens over the budget process institutions
citizens – Participatory – Direct engagement in
budgeting public good allocation
– Citizen
impeachment
(credible threat)
Lever 3: – Full – Greater inclusion of – Full citizen
Empower the decentralization of underrepresented engagement on
community public good groups in society local-level issues
allocation – More power to the – Changing
community, not local dysfunctional
government communities

On a community level, greater decision-making has a goal of greater civic

engagement and participation in democratic decision-making as its second-
order effect, thus strengthening the Second Lever, citizen empowerment.
Today, in many communities and societies, a lot of individuals feel
underrepresented, either due to their income, race, gender, nationality, or
otherwise. Many feel left out of social progress and seek radical changes
hoping this might change their position in society. The Second and Third
Levers directly aim to help underrepresented groups become more engaged
and more likely to be able to change their social outcomes by changing their
communities. Changing communities via greater civic engagement is much
easier and significantly more likely than changing national-level politics.
Community engagement is the first step to changing national-level outcomes.
The second-order effect is thus to teach people about democracy. Teach
them how to interact with others in their proximate community, particularly
those they disagree with. Teach them about the very process of how
decisions are being made, who is to be held accountable, have them
participate in raising issues, giving opinions, and making actual
contributions. Once people get accustomed to this, once they start seeing
social changes they’ve instigated, this will encourage them to further
increase their social engagement, thus raising both social trust and
democratic capital in a society.
The third-order effect is, finally, to improve trust and build democratic
capital. It is the cornerstone change that enables dysfunctional societies and
communities to break the negative cycle of underdevelopment. This will no
doubt be a process of trial and error, where many errors will be made, many
bad decisions reached, and many negative outcomes witnessed. But with
greater interpersonal trust, built through the process of community
engagement over collective action decision-making, members of a community
will continue down that path regardless of a few wrong choices. And the
final outcome will without doubt be beneficial to the community and its
members.
⋆⋆⋆
The Three Levers elaborated in this chapter do, however, leave a few open
issues. First, politicians have a legitimate interest to get elected, and there is
usually a divergence between their interests and the dispersed interests of the
citizens. What is the optimal way of resolving this conflict when the
motivation of a politician is much stronger than something we might refer to
as public interest? Are the superimposed rules that I mention in the First and
Second Lever enough? How can we expect politicians to even impose such
rules that would reduce their own power? Is there a group of citizens
powerful enough to impose the implementation of such rules, following the
long democratic trial-and-error process? How long should we be forced to
wait for the crucial societal reforms to take place? In other words, how can
we disempower politicians with minimum resistance?
The second set of issues concerns the question Friedrich Hayek asks in
the Road to Serfdom: “why do the worst get on top”?31 His response, based
on the experience of the rise of Nazism and fascism in 20th-century Europe,
was that the ruthless and unscrupulous spared no effort to reach the heights of
power in societies where hierarchical orders are handed too much power. If
selection into politics is on average adverse (as elaborated in Chapter 9),
how can we expect such individuals to ever agree to constrain their own
power? The issue is therefore whether the aforementioned gradual reforms
are enough to prevent the worst from rising to the top. After all, some
dictators and war criminals came to power via democratic elections (after
which they’ve abolished democracy, or made it pro forma). Can these
reforms be robust enough to prevent another potential autocratic or anocratic
ruler from reversing them?
Rules and constitutions are often changed under immense populist
pressure. To make sure that these rules become irreversible, we as a society
need to learn more about democracy. This is why community-level decision-
making is important—it teaches people about democratic decision-making. It
teaches people about the advantages and disadvantages of representative and
direct democracies, and which is better for which type of public good
allocation. Preventing the worse from coming to the top and breaking down
political pressure to lower their power is not something we can expect to
happen overnight, or through a violent revolution. It is a gradual, even
painful, process that might last for decades before we can see its first results.
Given the constraints that we face from too much political power and the
effect it renders on inequality, skewed opportunity, and wealth concentration
among elites, there is no alternative to a gradual democratic trial-and-error
that reduces political power to eliminate all of its malign outcomes.
 Afterword

Throughout the book I refer to elites and elite networks as something

inherently negative. Societies need elites. They have always existed and
always will exist. They have shown a remarkable level of persistence
throughout history, while its modern descendants have played positive roles
in developing societies, often even as agents of progressive change. The
problem is not with the existence of elites, it is about the way these elites
may capture corporate and political power and misuse it to prevent
opportunities for everyone else, and hence cause an increase in wealth
concentration and inequality.
Elites are just like politicians; good ones certainly do exist, but the
problem arises when the bad ones—with a far stronger motivation for
usurping power—take over and skew the distribution of resources and
opportunities within a society. This book has been about explaining how this
mechanism works and eventually finding solutions to constrain such
behavior. It adds the missing element in the explanations of long-term
inequality: the capture and misuse of political power.
If there is one thing, one line that should come out as the ultimate
conclusion of this entire study it is exactly that. Political power is the root
cause of inequality, through the mechanism of elite networks. Fixing this
issue requires taking aim at a different target: the cause, not the consequence.
 Notes

Introduction
1. The report, classified as “secret,” was published on WikiLeaks, and is available in full here: https://
wikileaks.org/plusd/cables/08TUNIS679_a.html.
2. Rijkers, Freund, and Nucifora (2014).
3. The Christian Democracy party dominated Italian politics for 50 years, winning power in every
single election since 1946 until 1992, except for one 3-year mandate by the Social Democrat
Benito Craxi, himself a victim of the Manu pulite investigation that got him convicted for
corruption.
4. Bloomberg Businessweek, June 2018: https://www.bloomberg.com/news/features/2017-06-08/no-
one-has-ever-made-a-corruption-machine-like-this-one.
5. Riordan (1995).
6. Ackerman (2005).
7. Riordan (1995).
8. Bueno De Mesquita and Smith (2011).
9. “Bell’s Rizzo sentenced to 12 years in prison,” Los Angeles Times, April 4, 2014: https://www.lati
mes.com/local/la-me-0417-rizzo-prison-20140417-story.html.
10. Abramoff (2012).
11. Fukuyama (2014).
12. Olson (1971).
13. Among others, Atkinson (2008, 2015); Atkinson and Piketty (2007, 2010); Atkinson, Piketty, and S
aez (2011); Banerjee and Duflo (2019); Milanović (2016); Piketty (2014); Piketty and Saez (2003),
etc.
14. Piketty (2014).
15. Such as Milanović (2016), Scheidel (2017), or Piketty (2020).
16. Shiller (2013).
17. Piketty (2014) does the most accurate description of this transition from capital-based to income-
based inequality, stating that the 20th century marked a switch from a “society of rentiers” to a
“society of supermanagers.”
18. Locke (2003[1690]), p. 46.
19. The argument emphasizing the crucial role of free trade in economic development has been
eloquently elaborated since Adam Smith (1776) and David Ricardo (1817).
20. Obviously, there are examples of societies achieving some form of economic development without
free trade, but all such examples are short-lived and their relative progress was entirely
unsustainable (like the example of the Soviet Union during Stalin). Read more about this in Acemo
glu and Robinson’s (2012) Why Nations Fail.
21. McCloskey (2012).
22. Mokyr (2016) and Ferguson (2017).
23. Chapters 5 and 7 develop this in greater depth by defining between-firm differences that depend
on type of industry and within-industry competition. There are rent-seeking firms, which build their
position on the political market, and there are customer-seeking firms, which build their position on
the market for customers. Rent-seeking firms are the ones seeking a nonmarket way—political
protection—of capturing a stronger market position. Their relationship with politics is the main
focus of this book.
24. North, Wallis, and Weingast (2010).
25. Acemoglu and Robinson (2019).
26. Ibid., Chapter 2.
27. Rajan (2019).
28. See Diamond (1997) or Cameron and Neal (2003).
29. Olson (2000).
30. Scheidel (2017).
31. Acemoglu and Robinson (2012).
32. Clark (2011).
33. Milanović, Lindert, and Williamson (2011).
34. According to Clark’s (2014) research on social mobility based on rare elite surnames.
35. Piketty (2014).
36. Clark (2014).
37. Atkinson, Piketty, and Saez (2011).
38. Bakija, Cole, and Heim (2012).
39. See Hacker and Pierson (2011) and Bonica et al. (2013).
40. Kuznets (1955).
41. Milanović (2016), Chapter 2.
42. Scheidel (2017), pp. 5–9.
43. Milanović (2016) also develops the argument that seemingly exogenous factors like wars and
revolutions are actually driven by internal structural factors that are triggered by unsustainably
high levels of inequality. Inequality does not go down itself but it sets in motion the events that
lower it. This, however, is difficult to prove and can fall into the standard trap of reverse causality.
44. See more in Piketty and Saez (2003), Milanović (2016, Chapter 2), and Scheidel (2017, Chapters
12 & 13).
45. Clark (2014).
46. Olson (1971), Chapters 1 & 2.
47. Olson (1982), Chapter 3.

Chapter 1
1. As defined by Tullock (1967), Stigler (1971), and Krueger (1974).
2. Dabla-Norris and Wade (2001).
3. Stiglitz (2012).
4. Furman and Orszag (2015).
5. Song et al. (2019) and Autor et al. (2020).
6. Lindsey and Teles (2017).
7. Scheidel (2017).
8. Piketty (2014).
9. Similar to Schoenman’s (2014) description of network creation in postcommunist societies.
10. Becker (1968).
11. Empirically shown by several studies including: Rundquist, Storm, and Peters (1977); Kurer (2001);
and Winters and Weitz-Shapiro (2013).
12. Transparency International (2021).
13. Weber (1978 [1922]).
14. Pareto (1935).
15. Mosca (1939).
16. Michels (1962 [1915]).
17. For example, Mills (1956), Endruweit (1984), Dye (2001), and Gilens (2012).
18. I touch on the democratic trial-and-error mechanism as a way to curtail elite network power, as
shown in the final part of the book, in Chapters 8 and 10.
19. Acemoglu and Robinson (2006).
20. Smith (1904 [1776]).
21. Ansell and Samuels (2014).
22. Ferguson (2017) makes a compelling argument to that end, detailing the spontaneous nature of
forming elite networks throughout history, while dismissing the conspiracy accusations even within
organizations like the Illuminati (Chapters 1 & 10) or the Freemasons (Chapter 20), both of which
certainly made contributions in their time, but their roles since have been vastly exaggerated.
23. In network theory these are called high-degree nodes, where the degree of a node determines the
total amount of other nodes connected to it (Jackson, 2010). Therefore, the scope of power for
one node is determined by the sum of all other nodes it is connected to.
24. Borondo et al. (2014).
25. Barbasi (2003) describes superhubs as highly connected leaders whose connections exert
influence over most other hubs and nodes. Navidi (2017) applies the same term to financial
networks in her book Superhubs.
26. The source of the data is a private company BoardEx which collects this type of data. Access to
the database has been granted via the Wharton Research Data Service (WRDS). See Chapter 4
for more details.
27. As, for example, used on LinkedIn. I ignore second- and third-level connections to superhubs,
given that these networks would be too large and would all look the same—as one huge circle.
28. Such as preventing the Commodity Futures Trading Commission (CFTC) from gaining oversight
on over-the-counter (OTC) derivatives. Alongside Fed Chairman Alan Greenspan, Rubin publicly
shot down the proposal of the CFTC then-chairperson Brooksley Born. Despite sounding early
warnings over the danger of derivatives, Born was forced to resign in 1999 after Congress
accepted Rubin and Greenspan’s proposals over hers. See Goodman (2008).
29. Nassim Taleb (2012, 2018) used this episode to coin the phrase “Bob Rubin trade,” describing a
decade of hidden risks being transferred from banks to the taxpayers, at the end of which bankers
like Rubin got away with huge payoffs, while the losses had to be carried by the taxpayers. It was
an asymmetric trade at its worst: the downside is protected by public money, while a select few
get to keep the entire upside. “Heads he wins, tails he shouts ‘Black Swan’ ” (Taleb, 2018, p. 13).
30. Cohan (2012).
31. Becker and Morgenson (2009) and Stewart (2009). The nine banks were: Bank of America, JP
Morgan Chase, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of NY Mellon,
State Street, and US Bancorp.
32. Their second-order ties were deliberately cut off to avoid congestion in the graph.
33. Meaning that these individuals are connected to each other despite also being connected to
Paulson through two different channels.
34. Acemoglu et al. (2016).
35. Moyer (2016).
36. Frank (2015).
37. Together with Vanguard and State Street, they (the Big Three) constitute the largest shareholder in
88% of all S&P500 companies. See Fichtner, Heemskerk, and Garcia-Bernardo (2017).
38. See, for example, Mills (1956), Guttsman (1965), Useem (1984), Ruostetsaari (2006), Maclean et
al. (2010), and Griffiths et al. (2014).

Chapter 2
1. Lenski (1966).
2. Milanović, Lindert, and Williamson (2011).
3. Trigger (2003), p. 142.
4. Scheidel (2017) refers to it as the “Great Disequalization,” while Harari (2011) calls it the “biggest
fraud in history” because it turned the Homo sapiens from free, egalitarian foragers into servants
of agricultural cycles, and introduced hierarchies, and by extension disparities, in the distribution of
wealth.
5. Marean (2014).
6. Brown et al. (2012).
7. Marean (2015) and Harari (2011).
8. Diamond (1997).
9. Harari (2011), p. 94.
10. Kohler et al. (2017).
11. Diamond (1997) diligently describes the geographical conditions that enabled this early
development.
12. Bogaard, Fochesato, and Bowles (2019).
13. Ibid.
14. Kohler et al. (2017).
15. Ibid.
16. Olson (2000), pp. 6–12.
17. It wasn’t the only social order, as Stasavage (2020) shows with a multitude of examples of early
democracies all over the world in ancient times, but these were limited to small-scale
environments. When the first empires arose, the violence power principle took over and
established a dominant hierarchical order wherever it penetrated.
18. Carneiro (1970)
19. Harari (2011), Chapter 6.
20. Ibid., p. 124.
21. Ibid., Chapter 8.
22. See for example: Abul-Magd (2002) or Stein (1994).
23. Scheidel (2017), p. 43.
24. Gregory Clark in his 2011 book A Farewell to Alms, Chapter 2, delivers a very accurate economic
portrayal of the Malthusian model that kept societies virtually constrained since the Agricultural
Revolution until the 1800s.
25. Scheidel (2017), p. 63–70.
26. Clark (2014), Chapter 9.
27. Scheidel (2017), pp. 71–79.
28. Milanović (2016), p. 68.
29. Frankopan (2015).
30. This is perfectly encapsulated in Machiavelli’s (1999[1532]) The Prince, a 16th-century political
treatise, paints a powerful image of the political structures that existed during his time, in particular
 showing how the papacy and the Church were very often at the very center of the political
dominance hierarchy.
31. Clark (2014).
32. Frankopan (2015), Chapters 6 & 7.
33. Piketty (2014), Chapter 10.
34. Acemoglu and Robinson (2006).
35. Ansell and Samuels (2014).
36. Wallerstein’s core, see Chapter 8.
37. Ferguson (2017).
38. It should be noted that even though the “robber barons” were clearly motivated by the violence
power principle while amassing their huge fortunes, later in life they’ve embraced the gift
exchange principle. Their philanthropic efforts, particularly in the United States, enabled building
thousands of schools, hospitals, colleges, museums, libraries, charities, cultural institutions, and the
like.
39. Scheidel (2017).
40. Note also how the share of wealth of the top 1% and 10% was lower in the United States than it
was in European countries in the 19th century. This is hardly surprising given that Europe (the Old
World) featured highly entrenched historical elites while the United States was a New World
country where elite networks were yet to develop to their full extent. However, by the end of the
20th century their roles were reversed: European elites held a lesser share of total wealth than did
American elites.
41. Piketty (2014), pp. 276–278.
42. Ibid., pp. 407–408.
43. Bakija, Cole, and Heim (2012).
44. Atkinson, Piketty, and Saez (2011).

Chapter 3
1. See Blanchard (1997) and Fidrmuc (2003).
2. See Milanović (1998) and Tucker (2006).
3. Miller, Grodeland, and Koshechkina (2001).
4. Przeworski (1991) and Tucker (2006).
5. Atkinson, Piketty, and Saez (2011).
6. This was most obviously portrayed in the entertainment industry: African American TV shows
started appearing on network television already in the 1970s but were gaining particular popularity
in the 1980s and 1990s (Soul Train started in 1971, Fat Albert a year later, followed by classics
such as Good Times, The Jeffersons, The Cosby Show, Family Matters, Fresh Prince of Bel-
Air, and of course the Oprah Winfrey Show starting in 1986). African American actors started
gaining prominence in Hollywood; the stereotypical black character in the 1950s was to some
extent related to crime (or slavery), while the stereotypical black character in the 1980s was the
chief of police—a huge difference in perception. Popular songs—arguably one of the biggest
embodiments was Donna Summer’s 1983 hit “She Works Hard for the Money”—ushered a new
era in women’s rights as women were finally being perceived as earners and potentially corporate
executives—a significant difference over the 1950s and 1960s perception of women as stay-at-
home moms.
7. Meltzer and Richard (1981).
8. Downs (1957).
9. Sirowy and Inkeles (1990).
10. Muller (1988), Simpson (1990), Burkhart (1997), and Huber et al. (2006).
11. Rodrik (1999) and Lee (2005).
12. Scheve and Stasavage (2009) and Acemoglu et al. (2019).
13. Kuznets (1955).
14. Olson (1982).
15. The data was taken from the IMF database based on a working paper by Mauro et al. (2013).
16. Tanzi and Schuknecht (2000), pp. 9–13.
17. Pigou (1932 [1920]), Samuelson (1983 [1947], 1954), and Arrow (1953).
18. Musgrave (1959).
19. Tanzi and Schuknecht (2000), pp. 32–45.
20. Friedman (1962) and Buchanan and Tullock (1962).
21. Tanzi and Schuknecht (2000), Chapter II.
22. See Mauro et al. (2013) for the most accurate depiction of historical debt trends. There have been
many hypotheses as to why debt levels have risen so substantively over the past decades. Alesina
and Perotti (1994) survey the literature and present six hypotheses to account for the rise in public
debt, all of which are politically motivated. These include the classical political business cycle
model, the intergenerational distribution argument, the role of political institutions a country has, its
distributional conflicts, its geographically dispersed interests, and even that parties may use public
debt as a strategic variable. Persson and Tabellini (2000) add to this political instability and the
common-pool problem (building on Olson, 1982) in the battle of groups over redistribution, where
powerful groups internalize benefits from public goods, while the costs are imposed on taxpayers
via either higher taxes or overborrowing.
23. Tanzi and Schuknecht (2000), p. 46, and Mauro et al. (2013).
24. Tanzi and Schuknecht (2000), pp. 26–27.
25. See Deaton’s (2013) The Great Escape for an overview of these trends.
26. Atkinson (2008), p. 5.
27. See Atkinson (2008), pp. 23–27, for a more detailed explanation.
28. Atkinson (2008), pp. 33–37.
29. Okun (1975), p. 66.
30. To borrow the terms from Acemoglu, Robinson, and Verdier (2017).
31. Atkinson et al. (2017).
32. Data on top income earner distribution is taken from Piketty and Saez (2003), and Atkinson, Pikett
y, and Saez (2011), while the indicators of wealth inequality and poverty are taken from Atkinson
and Piketty (2007, 2010).
33. Keep in mind that the periods of lowest reported inequality in the United States, the 1950s and
1960s, allowed huge parts of the population to remain disenfranchised from the benefits of
economic and productivity growth.
34. Atkinson, Piketty, and Saez (2011).
35. See, e.g., Atkinson (2008) or Autor (2014).
36. Case and Deaton (2020). Another factor that is often overlooked in the story of stagnating real
wages, at least in the United States, is the rising share of noncash benefits in the incomes of
lower- and middle-income workers. Mainly, health insurance premiums and pensions savings.
Such benefits will not be reported as taxable income in the official statistics; however, they should
show up in gross wages data. Therefore, the data on total income inequality could be slightly
biased upward, but the data on earnings dispersion should remain robust to this.
37. Atkinson (2015).
38. Deaton (2013).
39. Gabaix and Landier (2008).
40. Furman and Orszag (2015).
41. See Kahneman (2011), Chapter 20. A similar study was done by De Bondt and Thaler (1985).
42. Bertrand and Mullainathan (2001).
43. Piketty, Saez, and Stantcheva (2014).
44. Banerjee and Duflo (2019).
45. Shleifer (2012).
46. Fukuyama (2014).
47. Song et al. (2019).
48. Autor et al. (2020).
49. Philippon and Reshef (2013).
50. Ibid.
51. Bell and Van Reenen (2013).
52. Godechot (2012).
53. Greenwood and Scharfstein (2013).
54. Claessens and Perotti (2007).
55. See Albertus and Menaldo (2018) for more on how the old regime elites capture their newly
created democracies.
56. Stiglitz (2012), p. 32.
57. Furman and Orszag (2015). Their empirical finding is further supported by Song et al. (2019) and
Autor et al. (2020).
58. Lindsey and Teles (2017).
59. Svejnar and Bagchi (2015).
60. A similar finding was confirmed by Gupta et al. (2002), Glaeser et al. (2003), and You and Khagra
m (2005).
61. Gehlbach (2006); Hochberg et al. (2009); Mian, Sufi, and Trebbi (2010); and de Figueiredo and Ri
chter (2014).
62. Igan, Mishra, and Tressel (2012) and Blau, Brough, and Thomas (2013).
63. Vukovic (2021); Duchin and Sosyura (2012); Blau, Brough, and Thomas (2013); and Calomiris and
Khan (2015).
64. Evans (1996), Kelleher and Yackee (2009), and de Figueiredo and Silverman (2006, 2007) for the
United States; Alt et al. (1999) and Helland (2008) for Norway; or even to avoid paying taxes (Ri
chter et al. 2009 for the United States, and Schone et al. 2013 for France).
65. Deaton (2013), pp. 180–181.
66. For comparison, the child poverty rate in the United States is 21%, the African American poverty
rate is 26%, for Hispanics 24%, for Asians 12%, and for whites 10% (all data for 2014). The
overall poverty rate for 2015 in the United States was 13.5%. Source: US Census Bureau (2016).
67. Fortune Magazine (2005), “Fortune’s ‘Power 25.’ The 25 Most Effective Interest Groups.”
68. Center for Responsive Politics (2016).
69. Arguably in countries with inclusive institutions and a well-functioning constitutional order, when
such practices get uncovered, the actors get punished.
70. Bonica et al. (2013).
71. Bermeo (2009).
72. Hacker and Pierson (2011).
73. McChesney (1997).
74. Bartels (2016).
75. Gilens (2012).
76. Moss (2008).
77. Persson and Tabellini (2009).
 Chapter 4
1. Wharton Research Data Service (WRDS) (2017). The BoardEx dataset has been used in
academic research thus far, mostly focusing on network effects, mergers and acquisitions,
executive compensation, and corporate performance of CEOs (e.g., El-Khatib, Fogel, and Jandik 2
015; De Cesari and Ozkan 2015; Kim, Kogut, and Yang 2015; Schmidt 2015; etc.)
2. The UK dataset included more private, unlisted firms than the US case.
3. Relevance is determined either by geographical proximity (e.g., State representatives or city
mayors) or by key positions in government or the legislature (ministers, members of key
parliamentary committees, etc.).
4. BoardEx (2017) Data Dictionary.
5. The POLCON variable is disentangled by its two main components, previous government
experience and same organization membership. The conclusions are identical: no matter how we
define political connections, those who are connected in each case have a much larger average
network size.
6. The relative size of each individual’s network declines exponentially. In the United States more
than half have less than 1,000 connections, and 90% have less than 4,000 connections. There are
only a few extremes on the upper tail, but these do not affect the overall findings.
7. Topocratic networks are defined by Borondo et al. (2014).
8. See Atkinson et al. (2017).
9. The trends for absolute values of earnings and salaries for both countries point to the same
suggestion as their logarithmic versions in Figures 4.7 and 4.8.
10. Also with microlevel data there is always a potential problem with measurement error. If there is
measurement error in the data the additive random errors of the main explanatory variables could
bias the estimated coefficient toward zero.
11. Angrist and Krueger (2001).
12. Fisman and Svensson (2007) and Desai and Olofsgard (2011).

13. Calculated as .
14. This shouldn’t be surprising given the way I define the instrument with an emphasis on reducing
the measurement error. Angrist and Krueger (2001) suggest that in cases where there the
explanatory variable is likely to be biased due to measurement error, the estimated coefficients of
standard OLS regressions would be biased toward zero. In this case this means that the non-IV
estimates are likely to be lower than when correcting for potential measurement error using
industry-level averages of the explanatory variable.
15. For example, Fisman (2001); Faccio (2006); Faccio, Masulis, and McConnell (2006); Bellettini,
Ceroni, and Parolo (2013); etc. Chapter 7 presents these findings in greater depth.
16. Eggers and Hainmueller (2009).
17. Ding et al. (2015).
18. Wu et al. (2018).
19. Alonso and Simon (2023).
20. Kong et al. (2023).
21. Meyer et al. (2018).
22. Alregab (2015).

Chapter 5
 1. He was hardly the only one. Bloomberg’s reporters listed 64 former congressmen or senators in
2015 sitting on boards of companies they used to regulate. See Green, Kochkodin, and Migliozzi (2
016).
2. The tendency of highly connected individuals (high-degree nodes) to be connected with other
highly connected individuals. Also known as network homophily; attraction of similar individuals.
See Jackson (2010).
3. According to Borondo et al. (2014).
4. For example, a new law being passed, a regulatory opportunity, having privileged access to
government tenders, etc.
5. This is known as Dunbar’s (1992) number: the cognitive limit to the number of people one can
maintain successful social relationships with.
6. Jackson (2010).
7. Ibid.
8. The distribution is a pure Poisson, where the majority of individuals have low levels of connections
(mostly family and a few friends), while a very small number of people are highly connected.
9. Navidi (2017).
10. Ferguson (2000).
11. Ferguson (2017), Chapters 24 & 25.
12. The project features maps of various historical connections, from the networks of academic
economists and researchers, to social networks of citizens in 18th-century France, to the privilege
networks of powerful families or monarchs. The maps and the data are available here: https://histe
con.fas.harvard.edu/visualizing/index.html.
13. The project was led by Montserrat Cachero Vinuesa, and is available here: https://histecon.fas.har
vard.edu/visualizing/privileges/index.html. The full research is available in Cachero and Rodriguez-
Modrono (2022).
14. Charles V was a Habsburg born in Burgundy, and the Welsers rose to prominence as the bankers
of the Habsburgs. Hence the connection to the monarch.
15. Rothschild (2012).
16. Fisman (2001), Faccio (2006), and Desai and Olofsgard (2011).
17. Desai and Olofsgard (2011).
18. The empirical findings in Tanzi and Davoodi (1998), Faccio et al. (2006), Bellettini et al. (2013), Ga
rcia-Santana et al. (2020), or Gamberoni et al. (2016) confirm these insights for a number of
different countries.
19. Tullock (1967) and Krueger (1974).
20. Bandiera, Prat, and Valletti (2009); Fazekas, Toth, and King (2016); Fazekas and Kocsis (2017).
21. Song et al. (2019).
22. This finding is also supported by Card et al. (2013) for Germany, Hakanson et al. (2021) and Aker
man et al. (2013) for Sweden, Mueller et al. (2017) for the United Kingdom, and Alvarez et al. (20
18) for Brazil. Other papers that confirm the between-firm effect in the United States are Davis
and Haltiwagner (1991), Barth et al. (2016), and Furman and Orszag (2015).
23. This would be similar to the conclusions of Autor et al. (2020) on the effect of “superstar firms”
as the drivers of compensations at the top.
24. Note that the corresponding benefits do not drop. Convicted white-collar criminals tend to keep
most of their material possessions.
25. Note that point M represents an unstable equilibrium as agents have an incentive to move to the
right. They realize that one cannot stay below point M for too long and they expect total benefits
to start exceeding total costs after initial time and effort have been spent.
26. I am referring here to the motivation of gift-giving, not its administration. Inheritance is usually
regulated by a legal contract that is necessary to keep all parties satisfied.
27. Many inheritors of family business fortunes often squander their inherited wealth. If they lack the
competitive edge of their parents or grandparents, an equalization force should level the playing
field. However, as shown by Clark (2014) in The Son Also Rises, family fortunes can persist for
centuries. The problem here is that most such century-long fortunes were hardly a product of
voluntary exchange and were much more likely a product of coercion, violence, or proximity to
political power.
28. This change in rhetoric is most diligently portrayed in McCloskey’s (2012) Bourgeois Virtues,
while the impact of the change in culture is best explained by Mokyr (2016).

Chapter 6
1. A similar and often interchangeably used term in this context is patronage, where the rewards
from being part of a politician’s close network of supporters usually include being given jobs in the
public sector, exclusive government contracts, or other forms of protectionism. The literature
recognizes patronage as a particular form of clientelism (see Piattoni 2001, Root and Nellis 2000,
or Robinson and Verdier 2013).
2. Stokes et al. (2013).
3. For a definition, see Shleifer and Vishny (1993), Mauro (1995), Knack and Keefer (1995), and Ros
e-Ackerman (1978).
4. Gardiner (2002).
5. Shleifer and Vishny (1998).
6. This cynical conclusion is the foundation of the political agency literature; for examples, see Brenn
an and Buchanan (1980), Ferejohn (1986), and Besley (2006).
7. There is vast literature covering these issues: Coate and Morris (1995), McChesney (1997), Gross
man and Helpman (2002), Gilens (2012), and Gilens and Page (2014).
8. North, Wallis, and Weingeist (2010) call such societies limited access orders.
9. Buchanan and Tullock (1962) and Brennan and Buchanan (1980).
10. Bueno De Mesquita et al. (2005).
11. Besley (2004) and Casselli and Morrelli (2004) both follow that assumption.
12. A good overview of the logic and theory is given in Besley (2006).
13. The standard term limit assumption in Besley and Case (1995a, 1995b); Alt, Bueno De Mesquita,
and Rose (2011); and Ferraz and Finan (2011).
14. Austen-Smith and Banks (1989), Banks and Sundaram (1993), Besley and Case (1995a), Rogoff
(1990), Persson and Tabellini (2000), and Besley and Smart (2007).
15. For the United States, see Rundquist, Storm, and Peters (1977), who use a survey experiment to
confirm that voters trade-off corruption for other values in a candidate, while Peters and Welch (1
980) find that US Congressmen are less likely to be punished after being charged for corruption.
Almost identical findings were confirmed in Italy (Chang and Golden 2004; Golden 2004), Greece
(Dobratz and Whitfield 1992; Patrikios and Karyotis 2008), and Japan (Reed 1999; Nyblade and R
eed 2008).
16. See Ferraz and Finan (2011) and de Figueiredo, Hidalgo, and Kasahara (2012) for Brazil, Dimock
and Jacobson (1995) for the effect of the House banking scandal on US voters in 1992, or a
repeated study of US Congressmen from 1982 to 1990 by Welch and Hibbing (1997). The
literature examining this relationship in developing and emerging countries found evidence both in
support of the idea that corruption does not get punished at the polls (Manzetti and Wilson 2007; C
hang and Kerr 2017), and against it (Klasnja 2015; Klasnja, Tucker, and Deegan-Krause 2016).
17. See Rundquist, Storm, and Peters (1977), Kurer (2001), and Winters and Weitz-Shapiro (2013) for
a detailed overview of the hypotheses.
18. Downs (1957).
19. Ferraz and Finan (2011) famously show that this mechanism works in Brazil—an independent
audit on political corruption closed the informational asymmetry and the voters punished the
corrupt politicians.
20. Podobnik, Vuković, and Stanley (2015).
21. Verdier (1995) and Root and Nellis (2000).
22. Shleifer and Vishny (1998) and Besley (2006).
23. McChesney (1997) and Robinson and Verdier (2013).
24. Bueno De Mesquita et al. (2005).
25. I show this on the example of corruption in Croatian local government in Vuković (2019).
26. Nyblade and Reed (2008).
27. Vuković (2020).
28. Although no research has directly linked corruption to re-election, procurement-based corruption
was found to be high in a number of Eastern European countries, see Fazekas and Kocsis (2017).
29. Vuković (2019).

Chapter 7
1. Phelps (2013).
2. Acemoglu and Johnson (2023).
3. Typically, the political economy literature separates firms into rent-seekers and profit-seekers,
however, I deliberately use the term “customer-seeker” given that such firms achieve their profits
by satisfying and pandering to customers, not politicians.
4. Monopolies cannot exist without support and encouragement from the government. The
aforementioned examples of historical monopolies were clear cases of a government granting
monopoly rent-extraction rights in colonies to connected executives who in turn were allowed to
amass vast private fortunes. They were free to set high prices and achieve huge profits primarily
due to their realization of a nonmarket position bestowed to them by political power.
5. Facebook hired former UK deputy prime minister Nick Clegg to be their head of global affairs,
Apple named former US vice president Al Gore to their board of directors, while Google, Amazon,
and Microsoft all hired senior US government officials over the past decade.
6. The top 5 Big Tech companies (Amazon, Apple, Facebook, Google, Microsoft) spent more than
$60m on lobbying in both 2019 and 2020. Source: https://www.cnbc.com/2021/01/22/facebook-spe
nt-more-on-lobbying-than-any-other-big-tech-company-in-2020.html.
7. Stigler (1971).
8. Peltzman (1976).
9. Becker (1983).
10. Tullock (1967) and Krueger (1974).
11. McChesney (1997).
12. Beck, Hoskins, and Connolly (1992).
13. Shleifer and Vishny (1994, 1998).
14. Olson (1982).
15. Bellettini, Ceroni, and Prarolo (2013).
16. Fisman (2001).
17. Faccio (2006).
18. Goldman, Rocholl, and So (2009).
19. Eggers and Hainmueller (2009).
20. Jayachandran (2006) and Blanes i Vidal, Draca, and Fons-Rosen (2012).
21. See Faccio et al. (2006), Sapienza (2004), Dinc (2005), and Khwaja and Mian (2005).
22. Fan et al. (2007).
23. Gehlbach, Sonin, and Zhuravskaya (2010).
24. Earle and Gehlbach (2015).
25. Schoenman (2014).
26. Bertrand, Bombardini, and Trebbi (2014) and Blanes i Vidal, Draca, and Fons-Rosen (2012).
27. Correia (2014).
28. Vitali, Glattfelder, and Battiston (2011).
29. Their networking power, exhibited through high rates of network homophily and clustering, is well
documented, on a case-by-case basis, in Navidi (2017).
30. Kwak (2014).
31. Becker and Morgenson (2009) and Stewart (2009).
32. Walsh (2009).
33. Each of them wrote books about this, and they even wrote a book together to explain and justify
their decisions: Bernanke, Geithner, and Paulson (2019).
34. Vuković (2021).
35. Acemoglu et al. (2016).
36. Querubin and Snyder (2013).
37. Bradley, Gebrekidan, and McCann (2020).
38. Vuković (2021).
39. The Troubled Asset Relief Program (TARP) was drafted already in October and provided the
immediate necessary liquidity to the industry. It directly injected a total of $621 billion, with the
banks getting $372 billion (the rest went to the government mortgage giants, Fannie Mae and
Freddie Mac, the automobile industry, and AIG). At the same time, the lobbying and campaign
spending of the finance industry was on historical highs during 2008 and 2009. Firms that got
bailouts spent $114m in lobbying and campaign spending in 2008, and an additional $80m on
lobbying in 2009.
40. Abnormal lobbying is defined as the difference between actual lobbying that happened in 2008 and
2009, and the counterfactual estimate of lobbying—its precrisis moving average trend that
suggests how much money would have been spent on lobbying had it not been for the crisis. The
point of using abnormal lobbying is to eliminate the impact of precrisis aggregate lobbying and
focus only on what transpired in the immediate aftermath of the crisis.
41. Any established correlation of political connections with the allocation of bailouts still suffers from
omitted variable bias, does not address the self-selection problem of connected firms, and can
have potential reverse causality. For example, greater exposure to risk of bankruptcy could have
drawn both greater lobbying and donations, as well as the bailout allocation.
42. Vuković (2021).

Part III
1. To use the notation from Acemoglu and Robinson (2019), these are countries of a “Shackled
Leviathan” who are well within the “Narrow Corridor,” with the “Red Queen Effect” fully in
place.

Chapter 8
 1. Roser, Ortiz-Ospina, and Ritchie (2019).
2. Roser, Appel, and Ritchie (2019).
3. See Milanović (1991) and Bergson (1984).
4. One can hardly define China’s economic system as socialism (in fact, it is a pure example of
political capitalism, as defined in Milanović’s [2019] Capitalism, Alone), but with a socialist
government China may care more about a fair redistribution of income and wealth that a typical
capitalist country. Vietnam is a similar case of political capitalism.
5. There is no better evidence of this than in the popular literature. The works of Charles Dickens,
Jane Austen, Honoré de Balzac, or Émile Zola paint powerful images of terrible living standards of
workers in 19th-century England and France. This was the violence power principle at its worst.
6. Harari (2010) and Rajan (2019) describe this process in greater depth.
7. Ferguson’s (2008) Ascent of Money makes the most convincing argument of this case.
8. Acemoglu and Robinson (2019), Chapter 5.
9. Ferguson (2008), Chapter 1.
10. Acemoglu et al. (2011) show that areas which accepted these changes after the French retracted,
were set on a course of positive growth and development over the next century. In areas that
repealed the French reforms and reintroduced the old regime, institutions resisted positive change
and had worse economic outcomes.
11. Not exclusively, obviously, as socialist countries also delivered major reforms that produced rapid
industrialization (socialism was accepted primarily in less developed countries), and a form of the
welfare state, to a varying level of success. The last part of the chapter covers their development.
12. The continental exceptions include the Russian invasion of Ukraine in 2014 and particularly in 2022
(an event that prompted Ukraine to apply for both NATO and EU membership in the subsequent
months), as well as the failure of the European Community in 1991 to prevent the rise and
aggression of Serbian nationalism on Croatia and Bosnia and Herzegovina, leading to a devastating
five-year war in the Balkans (Glaurdić, 2011), and again in 1998 in Kosovo.
13. The core and the periphery are concepts developed by the economic historian Immanuel
Wallerstein in his 1974 classic The Modern World-System I: Capitalist Agriculture and the
Origins of the European World-Economy in the Sixteenth Century. He presents an initial
version of the world-systems theory that separates countries in the early stages of capitalism into
the core (British Empire, France, Germany/Prussia, Netherlands, Belgium, Austria, Spain,
Portugal, Italy), the semiperiphery (China, India, Argentina, Brazil, Mexico, Iran), and the
periphery (everyone else, most notably Russia, Eastern Europe, the rest of Latin America and
Asia, and Africa).
14. Gerschenkron (1962).
15. There were exceptions however, but they preceded the most rapid era of industrial development.
Emperor Joseph II of the Habsburg monarchy and the Holy Roman Empire and Empress
Catherine the Great of the Russian Empire were both lauded as Enlightenment monarchs of the
18th century, initiating a series of reforms. However, their successors had a much lower impetus
for change and actively prevented the progress of the Industrial Revolution. See Acemoglu and R
obinson (2012), Chapter 8.
16. Marx and Engels (2004 [1848]).
17. Milanović (2019).
18. Albertus and Menaldo (2018).
19. Triggering the “Red Queen Effect,” Acemoglu and Robinson (2019), Chapter 2.

Chapter 9
 1. An excellent overview of all the arguments in favor of such proposals is given in Banerjee and Du
flo (2019), Chapter 7.
2. Piketty, Saez, and Stantcheva (2014).
3. Saez, Slemrod, and Giertz (2012).
4. Piketty (2014, 2020).
5. A similar case is made for a decline of wealth inequality in the 20th century, given that progressive
rates were also applied to the inheritance tax. However, high top marginal inheritance rates were
only introduced in the United States and the United Kingdom (up to 70% and 80%), even though
wealth inequality went down across the developed world, mostly as a result of the structural shifts
in property ownership, as discussed in Chapter 2.
6. Germany and Italy made the majority of their nationalizations before the war, also contributing to
declining inequality. Italy during Mussolini’s rule at one point had three-quarters of its economy
nationalized. In Germany nationalizations continued after the war, particularly in the socialist East
Germany, where the majority of firms were placed under public ownership. West Germany took a
slightly different approach.
7. The most famous case-in-point was the nationalization of the car company Renault in France,
whose owner Louis Renault was accused of alleged collaborationism with the Nazis (which was
later disproved), arrested, and had all of his factories nationalized. It is easy to see how, in that
particular case, wealth inequality would go down.
8. Alstadsæter, Johannesen, and Zucman (2019).
9. Ibid, pp. 2098–2099.
10. He became the frontrunner in the race against incumbent President Sarkozy in May 2011, after
the current frontrunner Dominique Strauss Khan was arrested on suspicion of sexual assault in
New York.
11. “France Forced to Drop 75% Supertax after Meagre Returns,” The Guardian, December 2014, h
ttps://www.theguardian.com/world/2014/dec/31/france-drops-75percent-supertax.
12. “Indigestion for ‘Les Riches’ in a Plan for Higher Taxes,” New York Times, August 2012, https://
www.nytimes.com/2012/08/08/business/global/frances-les-riches-vow-to-leave-if-75-tax-rate-is-pa
ssed.html.
13. “After Depardieu, Belgian Plan by France’s Richest Man Fuels 75% Tax Row,” The Guardian,
January 2013. https://www.theguardian.com/business/2013/jan/24/belgian-move-bernard-arnault-fr
ance-tax.
14. “Wealthy French Take Their Assets to London,” Der Spiegel, May 2012, https://www.spiegel.de/i
nternational/europe/wealthy-french-flee-to-london-amid-fear-of-hollande-a-833814.html.
15. “France in 14 Billion Euro Tax Black Hole,” BBC News, May 2014, https://www.bbc.com/news/bu
siness-27602312.
16. Poterba (1987), Clotfeler (1983), and Crane and Nourzad (1990).
17. Fisman and Wei (2004).
18. Pommerehne and Weck-Hannemann (1996) and Chiarini, Marzano, and Schneider (2011).
19. Gilens (2012) shows that in American politics affluent voters carry a much higher weight in policy
decisions, and that low- and middle-income voters never get the policies they want when their
preferences diverge from those of the affluent voters.
20. See, e.g., Schouten and Silver’s (2012) book Almost a Psychopath or Eddy’s (2019) Why We
Elect Narcissists and Sociopaths—And How We Can Stop.
21. Acemoglu and Robinson (2019).
22. North, Wallis, and Weingeist (2010).
23. Ortiz-Ospina and Roser (2016), “Trust” (Public trust in government, United States, 1958 to 2015).
 Chapter 10
1. Administered via an official government website, USAspending.gov, https://www.usaspending.gov/
#/search.
2. The EC Financial Transparency System: https://ec.europa.eu/budget/fts/index_en.htm.
3. Besley and Prat (2006).
4. Petrova (2008).
5. DellaVigna and Kaplan (2007).
6. The Dubrovnik Republic arguably took it furthest. Even though it was an aristocratic republic,
ruled by the noble classes, it recognized a division of power (two houses of its parliament, an
executive branch, and even a supervisory body that ensured protection of the law), and had term
limits for its head of state—the rector—who was subject to a monthly change to prevent any
possibility of usurpation of power.
7. From Bueno De Mesquita et al. (2005).
8. A brief overview can be found here: https://www.europarl.europa.eu/workingpapers/juri/101/defau
lt_en.htm.
9. According to Arrow’s (1951) impossibility theorem.
10. The literature on this field of behavioral economics is vast and expanding. I recommend a few
titles: Kahneman’s (2011) Thinking, Fast and Slow, Ariely’s (2008) Predictably Irrational, Ake
rlof and Shiller’s (2015) Phishing for Phools, and Thaler’s (2016) Misbehaving.
11. The entire parliament can be held accountable in presidential systems where parliaments can be
the cause of gridlock and where bipartisan solutions are necessary to resolve important issues. In
parliamentary systems, this provision would only apply to governing coalitions (given that the
opposition often has no real power), unless the inaction is triggered by the opposition itself (if, for
example, one governing coalition party switches ranks and tries to exploit the rule).
12. A Condorcet winner is a preference aggregation mechanism that is considered the fairest, as it
implies choosing an option that beats all others in a pairwise vote. The Borda count voting
mechanism is much more likely to deliver a Condorcet winner than, for example, majority voting,
especially as the number of alternatives increases. See more in Black (1958).
13. Many developed countries use electronic and online voting for political office, so problems of
privacy, hacking, and anonymity are easily solvable.
14. If the legal system itself is inefficient or corrupt, the solution is not to take away its powers, but to
subject them to greater transparency and accountability, and by all means, remove any political
influence over it.
15. Nash (1950).
16. Chetty, Hendren, and Katz (2016).
17. Ostrom (1990).
18. Think of the 1946 classic film It’s a Wonderful Life, starring James Stewart as George Bailey, and
how the entire community comes to rescue him in his time of need, after he spent his entire life
helping the community. This is fiction, but it paints a clear picture of how community life was
perceived in the United States.
19. This is a reference to Shleifer’s book The Failure of Judges and the Rise of Regulators, where
the argument revolves around the systemic failure of the courts to handle disputes which increases
the demand for regulation.
20. Rajan (2019).
21. Putnam (2000).
22. Case and Deaton (2020).
23. For reference, see Tucker (2006).
24. Tavits and Letki (2014).
25. This too testifies to how much we as a society depend on political leaders and blame them for all
the faults in our own lives. Too much power is given to governments and we expect too much in
return.
26. Andris et al. (2015).
27. Rajan (2019).
28. Aghion et al. (2010).
29. This was exposed to a dramatic extent during the Eurozone sovereign debt crisis. Eventually,
international markets and other outside pressures led to downfalls of two governments, replacing
them with technocratic prime ministers in the most unstable countries in 2013, Italy and Greece.
30. According to the European Commission’s (2014) “EU Anti-Corruption Report”, procurement
corruption is the biggest source of corruption in EU Member States, reaching the size of the entire
annual EU budget. The report recognized too much discretionary power given to politicians and
bureaucrats as the biggest motivation for procurement corruption. See more at https://eur-lex.euro
pa.eu/legal-content/EN/ALL/?uri=celex%3A52014DC0038.
31. Title of Chapter 10 in Hayek’s (2007 [1944]) The Road to Serfdom.
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 Index

For the benefit of digital users, indexed terms that span two pages (e.g., 52–53) may, on
occasion, appear on only one of those pages.

accountability, xiii, 202, 203, 273, 274, 287–88, 289–90, 294, 295, 296
political, 278–79, 280, 281, 283, 286–87, 307
accumulation of power, 25, 29–30, 40–41, 232, 280, 291, 313
Acemoglu, Daron, 16, 18–19, 215, 271–72
Acemoglu and Robinson, 16, 18–19, 271–72
narrow corridor (NC), 16, 258, 271–72
Agricultural Revolution, vii, 17–18, 21–22, 71, 72, 73, 75, 81–82, 189–90
ancient times, 12, 77–78, 79, 82–83, 85–86, 91–92, 191
Ansell, Ben, xv, 43
assortativity, 9, 55, 58–59, 169, 177, 179
positive, 44, 172, 175
Atkinson, Tony, 20–21, 115–22
Austro-Hungarian Empire, 243–44, 248, 249
autocracies, 3–4, 40–41, 42, 77–78, 101–2, 106–7, 190, 203, 274
Autor, David, 36, 123–24

bailouts, 110–11, 224–25, 226, 227, 228–29

allocation, 31, 65–66, 226, 227–28, 229–30
Bankman-Fried, Sam, 5–6
Bank of America, 51, 57, 135–36
Bank of England, 55–57, 224
banks, 4, 37–38, 47, 54–55, 127, 171, 224–25, 229–30
big, 49, 51, 55–57, 124, 179, 224–25
bargaining power, 60, 62, 122, 123, 261–63, 314–15
Bartels, Larry, 129
Becker, Gary, 38, 218–19
behavior, xiii, 7, 13–14, 33, 63, 65–66, 80, 171–72, 198–99, 204
corrupt, 197, 206–7, 212
predatory, 14, 194
Bernanke, Ben, 49, 50–51, 53–55, 57, 135–36, 178, 224–25
betweenness centrality, 46, 53, 55, 58–59, 174, 175, 176–77, 179, 180, 182
Bezos, Jeff, 58–59, 96, 135–36
Biden, Joe, 310
Big Tech, xiii, 36, 123–24, 218, 224, 279–80
billionaires, 57, 126, 165, 267, 268
BlackRock, 58–59, 222
Blankfein, Lloyd, 57, 58–59, 135–36
BoardEx database, xvi, 132–33, 134–35, 136–37, 139–40, 173–74
board members, 6, 96, 136, 165, 173, 185
boards, 5–6, 36, 49, 133–35, 138, 154–55, 157–58, 159–60, 218, 220–21
Buchanan, James, 198
Bueno De Mesquita, Bruce, 198, 202
Buffet, Warren, 132, 135–36, 292
Bush, George, 223, 285

campaign donations, 7–8, 21, 30, 34–35, 62, 65–66, 132, 171, 173, 202–3, 226
capital, 9, 11, 18–20, 22, 83–84, 90–92, 93, 94–95, 96–97, 240, 315–16
capital gains, 20–21, 97, 120–22, 139–40, 261
capitalism, 30, 31–32, 90, 91–92, 99–100, 101–2, 231, 238–40, 241, 242, 243–44, 246–47
early, 9–10, 240, 244, 248
laissez-faire, 264–65
capitalism and democracy, 235–59
capitalist democracies, 31–32, 230, 233, 238–40, 244, 246–48, 256–57, 258–59, 263–64
Catholic Church, 85–86, 193, 241–42
CEOs, 55–57, 58–59, 96, 97, 122–23, 132, 133–34, 135–36, 164–65, 173, 217
bank, 57, 178, 226
connected, 165, 217–18, 220–21
corporate, 36, 66, 135–36, 175, 176–77
former, 50–51, 57
CFR (Council on Foreign Relations), 48–49, 53, 55–57, 58–59
Chartbook of economic inequality, 115, 117–20
China, 20, 40–41, 44–46, 73–74, 84, 89–90, 220–21, 238–40, 250–51, 275
Citigroup, 47–48, 51–52, 53, 57, 223, 224
citizens, vii, 32–33, 129–30, 255, 281, 286, 292, 293–94, 299–301, 302, 304, 305–7, 317, 318–20
civic engagement, 32, 286–87, 299–300, 303, 309, 318
Clark, Gregory, 19, 20, 23, 84, 89
clientelism, vii, 196–99
Clinton, Bill, 47–48, 51, 57, 223
Clinton administration, 48–49, 223
clustering, vii, 9, 44–46, 59, 61, 174–77, 178–79, 185, 315, 316
level of, 175–77
clusters, 9, 43–44, 46, 47–49, 51–52, 53, 172, 173–74, 175–76
collective action, 25, 108, 218–19, 308, 318
collective action problem, 7, 59–60, 63, 296, 313
collusion, vii, 2–5, 36–37, 61, 166, 218–21
communism, 43, 101–2, 112–13, 249, 263–64
communities, 32–33, 78, 281, 295, 296, 305, 308–9, 310, 311, 312–13, 314–15, 316, 318–20
dysfunctional, 310–11, 312–13
engagement, 311–12, 318
functional, 232, 312
local, 152, 295, 296, 308, 314, 315, 317
concentration of power, 9, 16, 17, 71–72, 84, 108, 169, 258, 296
Congress, 65–66, 127–28, 137, 226–27, 292
Congressmen, 5, 57, 137–38, 223, 227
connected executives, 30, 49–50, 66, 69–70, 133, 138–39, 145, 164, 217
connected firms, 7–8, 138–39, 184, 205, 206, 220–22, 225–26, 227–28, 229–30
connected individuals, 15–16, 29, 35–36, 44–46, 138, 145, 152, 172, 173, 184, 185
connections, 3–4, 5–6, 27, 34–36, 44–46, 59, 64, 97–98, 134–36, 137–38, 152, 155–56, 171, 173–74, 175
–76, 179–80, 273–74
corporate, 164, 227
deep, 49, 215, 218
direct, 166, 173, 227
firm, 153–54, 158, 162
high number of, 46
individual, 28–29, 44, 133, 134–35
industry-level, 154, 158–59
low levels of, 135, 175
social, 51, 174, 225, 229–30
conquest, 17–18, 83–84, 86, 241, 242
constraints, 7, 23–24, 72, 84, 85, 97, 98, 124–25, 243, 274, 307
institutional, 288, 292–93, 297
strong, 274, 292, 295
corporate boards, 46, 164, 169–70, 171, 195
corporate elites, vii, 23–24, 34–46, 61, 124–25, 171
corporate executives, xi–xii, 2–3, 7–8, 36, 46, 47–48, 49, 96–98, 164, 165, 166, 173, 230
corporations, i, 15, 38, 169, 213, 222, 291–92, 316, 317
corporatism, 213–14, 230, 231, 239–40
corruption, vii, 39–41, 65, 195–201, 204–6, 207–12, 273–74, 283, 312–13, 317–18
charges, 4–5, 205–6, 288–89
local, 209, 210
political, 4–5, 196, 200, 289, 298
punish, 39–40, 199, 200, 207
Council on Foreign Relations. See CFR
countries, corrupt, 216, 217–18, 273–74, 283, 284, 285, 286, 288–89, 298
credible threat, 32–33, 282, 292, 293–94, 296, 300, 307, 317, 318–20
crisis, 47, 49, 51, 110–11, 112–14, 140–45, 193, 224–26, 227, 229–30
Croatia, xv, 31, 40–41, 205, 206, 209, 210, 212, 251, 255
customer-seeking firms, vii, 9, 31, 169–70, 184, 185, 216–17

Davos, 55–57, 172, 315–16

Deaton, Angus, 121–22, 127–28, 309, 310, 311
degree centrality, 21, 29–30, 46, 97–98, 134–35, 153, 173, 174–76
democracies, vii, 30, 40, 41–42, 60, 61–62, 99–100, 101–2, 104–8, 128, 130, 200, 203, 242–47, 257–59
advanced, 7, 289–90
consolidated, 101–2
corrupt, 273, 289
developed, 110–11, 117–18, 130, 171, 205, 217–18, 287–88
direct, 293–94, 300, 303–4, 305
new, 245–46, 257–58
representative, 196, 290
rich, 40–41, 116, 120–21
 successful, 245–46, 274
democracy and inequality, vii, 99–131
democratic capital, 7, 33, 207, 233, 244, 311–12, 318
democratic capitalism, 31–32, 193, 232, 244, 257
democratization, 43, 69, 90, 91–92, 107–8, 243, 246–47, 257–58, 260
developed countries, 114, 124–25, 165, 199–200, 238, 247, 249, 275–77
Diamond, Jared, 73–74
dictators, 2, 60, 61, 62–63, 98–99, 202–3, 306, 320
Dimon, Jamie, 55–59, 135–36
dispersion of earnings, xi–xii, 116–17, 122, 177, 185, 217
distribution of income and wealth, 11–12, 18–19, 89, 169, 264
distribution of wealth, 17, 18, 29–30, 71, 82, 89, 91, 98, 174, 179
Downsian model, 105–6, 200

earnings, 115–17, 122–24, 136, 140–53, 157, 158–59, 162, 163, 166–67, 185, 265–66
abnormal, 9–10, 21, 29–30, 35–36, 164, 260–61
higher, 97–98, 124, 160–61, 164–65
inequality, 119–20, 164
Eastern Europe, 101–2, 130, 207, 248, 249, 254, 255–56, 257, 309
East India Company, 9–10, 182, 215
economic growth, 23–24, 25, 124, 126–27, 220, 241, 243, 244, 247, 250–51
effect of political connections, 42, 162, 163, 164–65
elections, 7–8, 38, 101–2, 188, 197, 206, 210, 226–27, 245–46, 288, 306–7
elite network behavior, 36–37, 39, 42, 59–60
elite network formation, xiii, 9–10, 30–31, 32, 33, 59, 189
elite networks, vii, 5–8, 26–28, 40–42, 44–46, 61–62, 64–67, 83–85, 86–90, 93–98, 132–33, 169–94, 211–
12
and inequality, 74–75, 76–77, 78–79, 80–81, 82, 84, 86, 88–89, 90, 92–93, 94–95, 96–97, 98–99
members, 6, 7–8, 11, 49–50, 51, 53, 62, 63, 66, 132–33, 266
membership, vii, 28, 38, 42, 59, 65, 166–67, 179, 186, 191–92, 194
new, 29–30, 93, 96, 97
power, 25, 130, 232, 289
relationships, 15, 49–50, 65, 169–70, 182, 216–17, 219–20, 222–23
superhubs, vii, 177–79, 180, 221–22
theory, vii, 16–17, 23, 31, 34, 36, 172–85, 205, 206–7
elite power, i, 1–33, 90–100, 130, 192–93, 258
elites, xii–xiii, xiv, 3–4, 16–17, 19, 20, 23–24, 25–26, 41–42, 43–44, 66–167, 172, 257–58
elite theory, vii, 41, 42
empires, 9–10, 18–19, 23, 79–80, 82, 84, 85, 89–90, 95–96, 180–82, 215
empirical findings, xv, 30–31, 46, 66, 184, 197, 218
England, 55–57, 86, 87–88, 89, 90, 91–94, 182, 224, 243
Enlightenment, xii–xiii, 14–15, 20, 88–89, 193
equality, 12, 29, 31–32, 231, 243
Europe, 85–86, 87–88, 89–90, 91, 93–94, 95–96, 108–9, 111–12, 192, 193, 235–38, 249
European Commission, 267–69, 283–84
exchange, voluntary, xii–xiii, 12, 17, 83–84, 169, 189–91, 194
executive earnings, 139–40, 145, 152, 153, 154–56, 157, 158, 160–62, 163, 164
executives, 51, 132–33, 136, 137–38, 139, 140, 145, 157, 162, 166–67, 169–70, 184–85, 217
executive salaries, vii, 42, 140–52, 163, 164–67

Ferguson, Niall, 92, 179

finance industry, 37–38, 124, 125, 127, 222, 226
financial crisis, 6, 59, 65–66, 110–11, 119–21, 222, 224–25, 226, 229–30
Fink, Larry, 58–59
firms, vii, 9–10, 34–36, 65–66, 133–38, 152, 173–74, 184–85, 206–7, 212–30
biggest, 123–24, 185
large, 122, 216
nonconnected, 139, 184, 220–21
rent-seeking, 65, 125–26, 184–85, 197, 215–17
superstar, 125–26
First Lever, vii, 281–99, 302, 303, 314, 316, 317
forces of occasional destruction, xiii–xiv, 23, 24, 25–26, 72, 85, 88–89, 90, 93, 265
forces of wealth accumulation, 31–32, 169, 190–91, 192–93, 244, 265
forces of wealth concentration, xiii, 23–26, 69–70, 72, 85, 87–90, 93–94, 97
France, 39–40, 91–92, 93–94, 95–96, 108–9, 115–16, 238–39, 243–44, 249, 251, 255–56, 261–63, 264, 26
6–69
Frankopan, Peter, xvi, 79
fraudulent procurement contracts, 31, 64, 65, 195, 197, 204
free exchange principle, 13, 92–93, 96–97, 190, 191, 193, 194
French Revolution, 95–96, 243–44
Friedman, Milton, 112
Fukuyama, Francis, 7, 123
Furman, Jason, 36, 126

Geithner, Timothy, 49, 50–53, 57, 58–59, 178, 223, 224–25

appointment, 51, 225
connections, 51–52, 53, 57
Germany, 87–89, 108–9, 111–12, 115, 117–19, 249, 255–56, 257, 261–63
Gerschenkron, Alexander, 247
gift exchange principle, 12, 13, 59, 189, 191
Gilens, Martin, 129–30
Gini coefficients, 76, 88–89, 106–7, 117–18, 275–77
Goldman Sachs, 2–3, 47–48, 49, 50–51, 53, 57, 135–36, 171, 223–24
governing institutions, vii, 16, 32, 197, 272–73, 318–20
government contracts, 15–16, 30, 34–35, 65, 132, 215–16, 217
government intervention, 111, 112, 311–12
governments, 1, 2–3, 15, 37–38, 64, 65–66, 108, 110–13, 114–15, 136, 191, 215–16, 217–18, 274, 275–77,
288, 293–94, 295–96, 306, 311–12
Greenspan, Alan, 224
groups, 7, 25, 37–38, 39–41, 42–44, 59–61, 62–64, 73, 108–9, 127–28, 202
narrow, 44–46, 62, 120, 129–30, 169, 171–72, 204, 272, 282
organized, 7, 40–41, 59–60
religious, 28–29, 30, 66, 132–33, 308, 309
small, 4–5, 9, 80–81, 176–77
underrepresented, 318–20
Harari, Yuval, 74, 78–79, 80
Harvard Center for History and Economics, 180
Hayek, Friedrich, 112, 320
hierarchical orders, vii, 77–81, 320
hierarchies, social, xii–xiii, 20–21, 97, 98, 105
Holmes, Elizabeth, 5–6
Homo sapiens, 13–14, 72, 73–74
human history, xi, 14–15, 16, 64–65, 66–67, 69, 97–99, 190, 191–92, 193
human rights, 31–32, 101–2, 189–90, 191–92, 231, 244, 246, 306
hunter-gatherers, vii, 72, 73–74, 75–77, 81–82

IMF (International Monetary Fund), 50–51, 53, 54–55, 108–9, 179

incentives, xii, 11–12, 15–16, 32, 42–43, 77–78, 184, 198–99, 201–2, 231, 247–48, 260, 274–75, 277, 278
–79, 289–90, 317–18
for elite network formation, xiv, 32, 33, 317
strong, 14, 25, 38, 43, 44, 79, 197, 198, 232–33, 293–94, 296
income and wealth inequality, 71, 99–100, 104, 105–6, 238–39, 263
income distribution, xi, 7–8, 11–12, 18–19, 20–21, 29, 57, 69–70, 89, 105–6
income inequality, i, 27, 66, 115–16, 117–20, 128–30, 139–40, 165, 166, 263, 267–68, 269–70
incomes, 7–8, 11–12, 18–21, 29, 34–35, 36, 83, 94–96, 105–6, 116–17, 118–21, 125, 215–16, 260–61, 267
–69, 270
capital-based, 95, 96–97
executive, 124, 139–45
higher, 36–37, 260, 263, 309, 316
income taxes, 263–64, 267, 268–69, 300–1, 302–3
Industrial Revolution, 13–15, 22–24, 29–30, 90–94, 193, 230, 231, 239–40, 241, 242, 248
inequality, vii, 7–8, 11–12, 21–24, 25–26, 34–37, 66–73, 87–89, 98–131, 230–32, 238–40, 260–63, 265–66
between-firm, 36, 126, 185
in democracies, vii, 106–7, 115–20
economic, xiii, 44–46, 82, 115, 117–20
high, 37, 59, 117–18, 128, 232, 275
higher, 27, 37, 69–70, 76–77, 106–7, 117–18, 125, 203
literature, 7–8, 29–30, 34, 185, 279
lower, xiv, 22–23, 32, 83, 104–6, 108, 265–66, 274, 280
rising, 7–8, 14, 27, 29–30, 97, 104, 126–27, 128, 129, 130
trends, 22–23, 25–26, 91, 105, 116–17, 132–33, 238–39
informational asymmetries, 44–46, 123, 174, 200, 201, 279
inheritance, 11, 13, 19–20, 76, 91–92, 94–96, 191, 194, 261
innovations, disruptive, 10–11, 92–93, 215, 231
institutions, 12–13, 16, 39–41, 130, 171–72, 189–90, 212, 257–58, 271–72, 273–74, 290–92, 301–2
personalized, 273–74, 275
strong, 7, 101, 274
interest groups, 25, 37–38, 40–41, 42, 63–64, 108, 127, 129–30, 177, 218–19
powerful, 3–4, 28–29, 127–28, 176
special, 25, 28–29, 128–29
state capture, 7, 104, 108, 214, 245
International Monetary Fund. See IMF
interpersonal trust, 232, 275–77, 308, 311–12, 317, 318
Japan, 20, 39–40, 44–46, 89, 104, 108–9, 111–12, 115–16, 117–19, 165
jobs, 2–3, 94–95, 96, 121, 122, 135–36, 204, 222, 223, 271–72, 273, 301, 302
agricultural, 241, 251
executive, 137–38
industrial, 251
labor-intensive, 213–14
low-skilled, 121
previous, 134–35, 156
Johnstone family, 180–82
JP Morgan, 9–10, 51, 52–53, 57, 135–36, 223
judges, 4, 180–82, 273–74, 290, 292, 308–9
corrupt, 288–89
justice system, 206, 257–58, 274, 314

Kahneman, Daniel, 122–23

Keynesian, 111, 112
key performance indicators (KPIs), 32–33, 282, 294
kings, 19–20, 61, 85–87, 91, 93, 95–97, 98–99, 180, 243
Kissinger, Henry, 5–6, 53, 195
Krueger, Anne, 50–51, 54–55
Kuznets, Simon, 22
Kuznets theory, 22, 107–8
curve, 232
first wave, 22
second wave, 22
waves, 22–23

labor, 11, 18–19, 20, 22, 84, 93, 94–96, 192, 213
cheap, 104–5, 240
exploited, 244
market, 29, 293
slave, 18, 83–84
unions, 40–41, 60, 62, 121–22, 176, 309
land, 18, 19–20, 75–76, 80–81, 82, 83–84, 85–86, 91–92, 93, 94–95, 97–98
agricultural, 284
ownership, 29–30, 76, 91–92, 94–95, 96–97
owners of, 11, 19–20, 69–70, 90
Latin America, 3, 40, 101–2, 112, 124–25, 130, 248
law, 4–5, 31–32, 171–72, 231, 270, 279–80, 286, 289, 290, 291, 314, 315–16
leaders, 4, 64, 78, 79, 81, 98, 202–3, 271, 273, 297, 313
political, 79, 198, 270–71
legislation, 7–8, 11, 34–35, 130, 171, 217–18, 219, 270, 272, 279–80, 299
favorable, 31, 34–35, 38, 40–41, 127, 169–70, 202–3
legislators, 3, 137, 160, 218–19, 224–25, 270, 298–99
legitimacy, xii, 13–14, 71, 86, 191–92, 194, 244, 292–93
levers, vii, 33, 34, 232–33, 278–81, 296, 299–300, 316–17, 318–20
Lew, Jack, 51–53, 57, 135–36, 223
limited access orders, 16–17, 273
links, i, 46, 55–57, 128, 129, 134–35, 137, 164, 174–75
direct, 65–66, 86, 163, 164–65
random, 174–75
superhub, 59
living standards, xi, 3–4, 82, 83, 90, 92–93, 94–95, 99, 101–2, 235, 239–40
lobby groups, 60–61, 62
lobbying, xvi, 10–11, 65–66, 125, 127–28, 216, 217, 219, 298–99
activities, 7, 127, 218
efforts, 127–28, 226
expenditures, 127
finance industry, 171
lobbyists, 37–38, 62, 63–64, 219, 220, 221–22, 265–66, 298–99
local governments, xv, 2–3, 32–33, 203, 204, 282–83, 289–90, 295, 297, 312, 313

Madoff, Bernie, 6, 7
Malthusian, xi, 72, 85, 90, 98–99
economic model, vii, 81–85
subsistence, 244
times, 87–88, 90, 241
trap, 14, 18–19, 23–24, 83, 90, 192–93, 246–47
managers, 28–29, 36, 92, 96–97, 136
society of, vii, 20, 90–100
market, xiii, 15, 98, 112–13, 184–85, 215–17, 218, 225, 260–61
dominance, xiii, 10–11, 15, 220
economy, 111–12, 264–65
failures, 260–61, 291
financial, 20, 96, 97, 178
mechanism, 9, 11, 174, 191
political, 185, 198
power, i, 15, 34–35, 164, 216–17
Marx, Karl, 91–92, 240, 249
Maslow, Abraham, 177–78, 189
Mauro, Paolo, 108–9
mayors, 137–38, 204, 206, 209, 210, 287
corrupt, 5–6, 203
local, 3, 207–8, 210, 287
McChesney, Fred, 1, 3–4, 128–29, 219
mechanism, 7–8, 9, 29–30, 177, 179, 184–85, 200, 202, 203, 204, 300
democratic trial-and-error, 32, 128, 277, 280
violence power, xii–xiii, 14
well-defined institutional, 21, 232
media, 6, 96, 200, 244, 278–79, 284, 285, 286–87, 289–90, 302
captured, 285, 286
free, 32–33, 203, 281, 285, 286, 317, 318–20
independent, vii, 284–85, 286–87
Meltzer, Allan, 105–6, 128–29
members, 25, 28, 41–42, 59–60, 61–64, 66, 132–34, 135–36, 137–38, 166, 182, 201, 202–3, 207–8, 210, 3
08–9, 312–13, 318
 active, 53, 136–37
connected, 176, 201
of elite networks, 62, 82, 185
of parliament, 137, 164, 182, 206
Menaldo, Victor, xv, 257–58
mercantilism, 85, 240, 242
Middle Ages, vii, 13–14, 19, 22–23, 85–86, 87–88, 89, 189, 191, 193, 235–38
middle classes, 43, 90, 91–93, 95, 104, 121, 123, 129–30, 213–14
Milanović, Branko, 19, 22, 23, 71–72
minimum winning coalitions, vii, 195, 202, 205–12, 287, 307
misuse, 4–5, 10–11, 14, 35–36, 171–72, 197, 212, 219, 278–80, 298
of political power, xiii, 36–37, 232
of power, 7–8, 11, 15, 35–37, 166, 274
money, 5–6, 59–60, 186, 188, 241–42, 282–83, 298–99, 300–1, 302–3
laundering, 1–2, 5
for nothing, 128–29, 219
and power, 60–61, 62–63
taxpayer, 302–3
monopolies, xii, 3, 7–8, 16, 86, 96–97, 126, 193, 216–17, 296
natural, 215–16, 282–83
monopoly rights, 10–11, 215, 240, 295
motivation, 169, 189–90, 192–93, 194, 201, 226, 230, 283, 284, 286
for corruption, 206, 283
for politicians, vii, 195–212
municipalities, 37–38, 206–10, 287
Murdoch, 58–59
James, 57
Rupert, 285

Navidi, Sandra, 34, 55–57, 177

network centrality, 46, 47, 49, 173, 188
network effect, xiv, 9, 21, 66, 97, 157, 160, 162, 163, 166
networks, 44–46, 47–49, 51–53, 55–57, 58–59, 97–99, 133–36, 171–75, 176–78, 180–82, 187–89, 201–2
close, 38, 185, 196, 299
homophily, 9, 30–31, 169, 176, 178–79, 182, 315
of influence, 21, 29–30, 64–65
larger, 54, 135, 139, 152, 163
political, 98–99, 177–78
powerful, 5, 57, 171–72, 177, 200
superhubs, 29
topocratic, 9, 30–31, 44–46, 59, 139, 169, 172, 175
network size, vii, 134–36, 139, 152, 154–55, 156, 157–58, 159, 161, 162
effect, 155, 158
firm, 157–58, 162–63
network theory, 30–31, 46, 169, 184, 189, 203
NGOs, 21, 28–29, 51, 60, 62, 63–64, 66, 136–37, 160, 166
nobility, xii, 7–8, 9–10, 19–20, 85–86, 89–90, 91, 182, 240, 242, 243
nobles, 3–4, 43, 69–70, 84, 86, 87, 93, 96–97, 98–99, 189, 191–92
nodes, 21, 46, 53, 54–55, 173–76, 177–78, 180, 182, 188, 316
connected, 173, 174, 222
highest-degree, 175, 177–78, 188–89
important, 55–57, 173, 177
low-degree, 175, 188

Obama, Barack, 49, 51, 53, 223

Obama administration, 47–48, 51, 53, 223, 292
office-holders, 206–7, 224–25, 226, 282, 287, 292–94, 317
officials, elected, vii, 287, 288, 291, 305–7
Olson, Mancur, 7, 18, 25, 28–29, 59–60, 77–78, 128–29, 213, 220
Olson’s interest group theory, 28–29, 41–42, 108
Olson’s logic of group behavior, 25, 29, 41, 43, 218–19
open access orders, 16, 17, 273
organizations, 4, 60, 132–38, 145–52, 156–57, 160–61, 302
alumni, 136–37, 227
charity, 62, 135–36, 302, 308
lobby, 63, 315–16
military, 64, 136–37
professional, 30, 132–34, 136–37, 166
religious, 17–18, 42, 62, 63–64, 136–37
social, 16, 241
Orszag, Peter, 36, 47–48, 126, 135–36, 223
owners of capital, xii, 69–70, 90, 93, 94, 165, 179, 240, 244

Paulson, Henry, 49, 50–51, 52–53, 57, 58–59, 178, 223, 224–25
network, 50–51
Peltzman, Sam, 218–19, 220
Phelps, Edmund, 213
Piketty, Thomas, 19–21, 23, 36, 37, 91–92, 93–96, 118–19, 120–21, 123, 261–63
POLCON, 136, 145, 152–53, 154–56, 159, 161
policies, 33, 47, 129–30, 198–99, 224–25, 259, 260, 261, 288, 289–90
austerity, 110–11, 112–13
changes, 123, 130, 265, 272, 277, 278–79
fiscal, 112–13, 293–94
monetary, 293, 294
optimal, 198–99, 261–63, 266, 305
regulatory, 128–29, 218
policy complexity, 123, 294, 296
political connections, 5–6, 35–36, 41–42, 65–66, 125–26, 136, 138–39, 145–52, 154–56, 157–58, 159–63,
164–66, 215–16, 217–18, 220–21, 226–27, 228–29
of board members, 165
of corporate executives, 7–8, 132, 260–61
direct, 155, 158, 166–67
firm, 65–66, 138, 145, 158, 164
and network size, vii, 139, 154–55
political elites, 37–38, 41, 92, 130, 197, 202, 212, 257
political influence, 6, 11, 98, 127, 184, 255, 286
political institutions, 26, 206, 299
political orders, 16–17, 23–24, 42, 72, 190
political parties, 15, 42, 62, 63–64, 126–27, 129, 136–37, 166, 176, 205–6
political power, xiii, 3–4, 9–10, 11, 15–16, 18–19, 21, 23–24, 31–32, 41–42, 69–70, 82–83, 96–97, 225–26,
270–72, 278, 299
centralized, i, 33, 295
discretionary, 282, 291–92
extractive, i, 7–8, 192–93, 274
lowering, xiv, 31–33, 194, 232, 274, 280, 281, 297, 298, 299
political process, 10–11, 16–17, 34–36, 125, 128, 130, 196, 219, 265–66, 270
political protection, xiii, 6, 165, 166, 214, 215, 216–17
political rents, 34–35, 184, 198–99, 201–2
political survival, vii, 26, 31, 38, 65, 197, 202, 204, 212
political systems, 8, 39, 98–99, 101–2, 120, 126–27, 128, 164–65, 182, 206–7
politicians, 30–31, 37–38, 42, 64–66, 136–37, 166–67, 195, 196–99, 200–1, 202–3, 204–5, 206–8, 210, 21
8–19, 227–29, 271–72, 288–90, 292–94
bad, 198, 199, 205
corrupt, 65, 199–200, 287–88, 289–90
elected, 7–8, 69–70, 169–70, 180
and firms, 7–8, 27, 29, 194, 201, 206, 220, 317
former, 5–6, 53, 54–55, 218
incumbent, 197–98, 199–200
local, 206, 210, 295, 297
office-holding, 5–6, 30, 65, 169, 171, 282, 317–18
politicians in power, xi–xii, 28–29, 129–30, 132, 185, 197, 198–99, 207, 210, 287–89
position of power, 3–4, 43, 44–46, 55–57, 59, 169–70, 171–72, 222–23, 225, 226, 229–30
poverty, xi, 3–4, 13, 101–2, 105, 115, 118, 119–20, 233, 235–38, 239–40
declining, 238, 239–40
extreme, 235–38
reduced, 32, 115
power, 7–8, 13–17, 25, 28–29, 34–37, 40–42, 59, 71–72, 177–78, 191–93, 197, 210, 257–59, 270–72, 287
–88, 307, 312–14, 318–20
corporate, xi, 98–99, 125–26, 233, 296
discretionary, 65, 287, 292
holding, xii, 82, 196–97, 272, 274, 287, 307
relative, 29, 60, 287
rising, 91–92, 124–25, 220
structures, 16, 81, 98, 189–90
privatization schemes, 124–25, 219–20, 257
privileged access, 2, 34–35, 123, 174
privileged position, 11, 15, 98, 184
privileges, xiv, 9, 10–11, 23–24, 71–72, 83, 91–92, 180–82, 192, 202, 229–30
procurement contracts, 34–35, 65, 98, 204, 206–7, 209, 212, 217–18, 225–26, 279–80
corruption, 207–10, 312–13
exclusive, 2–3, 31, 38, 169–70, 171, 205–6
public, 65, 197–98, 204, 206–7
suspicious, 26, 207–9, 210
productivity, 8, 21, 99, 184, 185, 213–15, 235
 growth, xiii, 104–5
total factor, 214–15
progress, xii–xiii, xiv, 12, 104–5, 214–15, 230, 231, 247, 248, 250–51, 255–57
social, 31–32, 249, 272, 275–77, 318
progressive taxation, vii, 32, 260–70
protection, xiii, 15–16, 77–78, 81, 82, 84, 189–90, 215–16, 217
demand for, 18, 36, 75, 78, 81
proximity to political power, xiii, 13, 18–19, 21–22, 69–70, 96, 97, 98, 225–26
public goods, 30, 32–33, 198, 199, 204, 205, 296, 303–4, 312, 313, 314–15
necessary, xii–xiii, 3, 190–91, 274, 296, 305
provision, 281, 292, 295, 300, 308
public officials, 46, 49–50, 53, 54–55, 57, 59, 287, 289, 291
public service, 47, 52–53, 202–3, 223, 224, 230, 271, 274, 300, 302–3, 315
punishment, xiv, 171–72, 188, 200–1, 202, 203, 292–93, 294, 295, 296, 306–7
Putnam, Robert, 309

Rajan, Raghuram, 308–9, 311

Reagan, Ronald, 47–48
administrations, 112–13
reducing political power, vii, 231, 232–33, 280, 281
re-election, 199–200, 204, 205, 206, 207–8
reforms, 32–33, 124–25, 194, 232, 233, 264–65, 278, 282–83, 297, 298, 303, 318–20
regulations, 30, 31, 128–29, 130, 132, 218–19, 230, 279, 295–96, 311–12
favorable, xi–xii, 7–8, 34–35, 171, 196, 218–19, 220
rent-extraction, vii, 3, 11, 18–19, 31, 85, 195–99, 219
rentiers, society of, vii, 20, 90–100
rents, 10–11, 19–20, 34–36, 94–96, 169–70, 171, 197–98, 199, 261
extracting, vii, 31, 169–70, 185, 195–212
rent-seekers, xiii, 9, 31, 126, 169–70, 184–85, 216–17, 218
rent-seeking, vii, 10, 11, 31, 34–35, 36, 50–51, 84, 216–18, 219
Richard, Scott F., 105–6, 128–29
robber barons, 4, 7, 9–10, 295
Robin Hood Foundation, 58–59, 135–36
Robinson, James, 16, 18–19, 271–72
role of government, 111, 114, 115
roving bandits, 18, 77–78, 81, 189–90
Rubin,Robert, 47–49, 50–53, 59, 223
appointment, 51
network, 47–48, 49
rule of law, 31–32, 101, 231, 279–80, 314
rules, 79–80, 89–90, 130, 189–90, 212, 257–58, 272, 288, 290, 291, 292–93, 294, 305–6, 307, 318–20
ruling elites, xiv, 13–14, 16, 17, 18–19, 69, 71–72, 77–79

Saez, Emmanuel, 36, 120–21, 123, 261–63

salaries, 97, 122, 124, 139–52, 154–55, 156–58, 159–60, 161–62, 163, 164–65
higher, xi–xii, 27, 30, 66, 69–70, 145, 152, 154–55, 157–59, 217
Scheidel, Walter, 18–19, 23, 37, 82, 87–89, 93, 118–19, 265
Second Lever, vii, 32–33, 286, 300, 313–14, 318–20
selectorate theory, vii, 31, 195, 201–5, 287
Shiller, Robert, 10
Smith, Adam, 43, 182, 202
social capital, 26, 232, 296, 309, 311–12
socialism, 23, 90, 91–92, 111, 238–39, 246–48, 249–51, 254–55
socialist countries, 31–32, 98–99, 101–2, 238–39, 250–51, 254, 256–57, 264
social mobility, 19, 20, 29, 41–42, 84, 89, 104, 240
social networks, 44, 64, 136, 166–67, 172, 174–75, 185, 227, 229–30
informal, i, 7–8, 34
societies, xiii–xiv, 11–12, 13–14, 16–17, 25–26, 28, 29–30, 37, 41–43, 85–86, 88–89, 105–6, 190–91, 192
–94, 241, 272, 277, 318
ancient, 82
developed, 22, 249, 312–13
dysfunctional, 277, 281, 318
hunter-gatherer, 18–19, 72
modern, xi, 23–24, 231, 238
preindustrial, 19, 23–24, 71–72, 83–84, 90
Soros, George, 55–57, 135–36
Soviet Union, 101–2, 238–39, 247, 249, 251, 254–55, 256–57
special interests, 14, 42, 124–25, 128–30, 196, 197
state failures, xiii–xiv, 23, 87–88, 99–100
stationary bandit, 18–19, 77–78, 81, 83, 85–86, 87–88, 89, 98–99, 189–90, 194
Stiglitz, Joseph, 36, 126
superhubs, 5, 34, 46, 47, 55–57, 173–74, 177, 224
supermanagers, 8, 21, 29–30, 37, 66, 69–70, 118–19

Tammany Hall, 4, 7, 9–10, 93, 182, 240, 258

Tanzi and Schuknecht, 113–14
TARP (Troubled Asset Relief Program), vii, 49, 65–66, 224–25, 226–30
Tax allotment, 281, 302, 317, 318–20
taxation, 128, 232, 242, 259, 263–64, 269
taxes, 128–29, 260, 261, 263, 266–67, 268–69, 272, 293–94, 295, 296, 297, 298
tax evasion, 261–63, 265–66, 267–69, 270
tax payments, vii, 281, 300–1, 302
tax rates, 207–8, 211–12, 263, 297
higher, 211–12, 261, 263, 265–66, 268–69
marginal, xiv, 123, 261–63, 266–67, 268–69
tax revenues, 207–8, 242, 268–69, 300–1, 302
technological progress, 8, 18–19, 75, 121, 123, 214–15, 257, 309
Third Lever, vii, 32–33, 295, 308–16, 318
top executives, 11, 27, 34, 123, 124, 164, 185, 260–61, 317–18
top income earners, 7–8, 30, 34, 36–37, 116, 118–19, 122, 130, 260–61
top incomes, 21, 42, 49–50, 97, 98, 116–17, 119–20, 122, 124, 139–40, 145
total earnings, 30, 66, 140–52, 153, 154–55, 157, 159, 161–62, 163
transparency, 245–46, 278–80, 283, 284–85, 286–87, 289–90, 295, 296, 317
trial-and-error, vii, 246–59, 280
mechanism, xiv, 26, 31–32, 280, 313
process, vii, 232, 233, 245–46, 258–59, 264–65, 275, 277
Troubled Asset Relief Program. See TARP
Trump, Donald, 57, 274, 309–10
Trump administration, 223, 274
trust, vii, 12, 32, 33, 98, 178–79, 241–42, 275–77, 311–12
declining, 32
in public institutions, 272, 275, 277, 281, 282, 284, 296, 308, 317
rebuilding, xiv, 26, 275, 277, 280, 282, 284, 287, 317
social, 266, 280, 313, 318
Tullock, Gordon, 198, 219

unemployment, 111, 112, 115, 244, 254, 257, 293, 309

unequal distribution of wealth, 66–67, 69, 75, 190–91
unions, 60–61, 62, 63–64, 121–22, 202–3, 244, 287, 314
United Kingdom, 27, 109, 116–20, 124, 133–34, 137–39, 140–52, 159–64, 165, 166, 238–39, 251, 261, 26
4–65, 285
United States, 44–46, 93–94, 104–5, 111–13, 116–20, 123–24, 127–30, 133–34, 137–38, 140–52, 154–55,
157–62, 166, 238–39, 261, 274, 309–10
use of violence, xii, 13–14, 16–17, 18, 25, 81, 194

violence, xi, 13–15, 16, 18, 73, 77–78, 80–81, 83–84, 189, 190, 191–92
violence power principle, xii, 12, 13–14, 15, 16–17, 30–32, 89–90, 191–94
voluntary exchange principle, xii–xiii, 12, 14–15, 16–17, 96–97, 99, 189, 190–91, 193
voters, 128–30, 196, 197, 198–201, 202–3, 204, 205, 206, 207, 294, 314, 315
median, 105, 106–7, 257–58
Vuković, Vuk, i, 1–2, 34–35, 71–72, 101–2, 132–33, 171–72, 195, 207–8, 209–10

wage premium, 124, 132–33, 153, 158, 160, 166

wages, 83, 94, 95–96, 97, 101–2, 121–22, 140–52, 154–55, 156, 166–67, 314
Wall Street, 5–6, 47, 48–49, 52–53, 223, 224
wealth, 11–13, 14–15, 17–20, 23–24, 35–36, 66–67, 69, 71–72, 75, 76, 85, 89–90, 91–92, 93–97, 98–100,
126, 191
wealth accumulation, 14–15, 17, 31–32, 85, 190–91, 192–93, 230, 232, 233, 265, 297
wealth concentration, xiii, 8, 9, 23–26, 69–70, 82–83, 85, 87–90, 95–96, 238
wealth inequality, 2, 11, 19, 87–88, 95–96, 98–100, 104, 105–6, 118, 119–20
welfare state, 20, 23, 99–100, 104, 105–6, 108, 111–12, 113, 115, 263, 264–65
Wharton Research Data Service. See WRDS
WID. See World Inequality Database
winning coalitions, 202–3, 210, 287–88, 312–13
powerful, 203, 212, 287–88
small, 31, 202, 287–88, 306
World Economic Forum, 49, 58–59, 172
World Inequality Database (WID), 238–39, 261–63, 267–68
World War II, 23, 28–29, 110–11, 118–19, 215, 239–40, 249, 258–59, 263–64
WRDS (Wharton Research Data Service), xvi, 133
W/S ratio, 202, 210, 211–12