This is the fifth installment in my series of article about the predictive and policy failures of Roger Myerson, Nobel Laureate in economics in 2007. My first two articles [here and here] critiqued his claim that capitalism’s unique advantage over communism is plutocracy because only exceptionally wealthy CEOs can be successfully bribed by their shareholders to “imitate” “good” CEOs who will not cheat the shareholders.
My third article noted that his September 2012 article argues that:
“In this sense, a tax on poor workers to subsidize rich bankers may actually benefit the workers, as the increase of investment and employment can raise their wages by more than the cost of the tax [p. 25].”
That same September article provided the basis for my [fourth article, which is a] critique of Myerson’s internally inconsistent analytics and disastrous policy proposals concerning executive compensation.
This article discusses the similar analytical and policy flaws in Myerson’s ode to crony capitalism.
Myerson’s political theory: if he buys you a nice dinner he has a right to sleep with you
In his December 8, 2007 Prize lecture, as the economic system was crumbling, Myerson announced his ode to plutocracy and its handmaiden – crony capitalism. Myerson is explicit in claiming that only exceptionally wealthy people can be trusted to be CEOs. Under his model the bribe that the shareholders would have to pay a merely rich CEO to “imitate” a “good” CEO is so large that the net social value of the corporation becomes negative. Only the World’s wealthiest need apply to be CEOs under Myerson’s logic and model.
“This amount is negative when A<40. So in this example, we cannot get any positive expected profit for society unless the manager himself can contribute assets A worth at least 40. That is, to deter abuse of power without an expected loss to the rest of society, the manager must have stakes in this project worth at least 40% of the cost of the capital input here. If no one has such a large personal wealth to offer as collateral to this investment, as might be the case in an egalitarian socialist society, then society at large cannot profitably undertake this investment.
Thus, moral-hazard incentive constraints can also provide an analytical framework where the initial allocation of property rights may affect the possibility of productive investments. Indeed, this simple example may provide an analytical perspective on problems of socialism, as Hayek was seeking. Modern industrial production requires integrated managerial control over large scale assets, and whoever exercises that control will have great moral-hazard temptations, which are represented by the parameter B in this model. When managers have great temptations B, the moral-hazard incentive constraint cannot be satisfied unless managers have large stakes in [the] success of their projects” [p. 334]. [from Myerson’s Nobel prize lecture.]
As I explained in my prior articles, Myerson’s model would require the CEO of a mid-sized bank with $20 billion in assets and $1 billion in capital to invest $400 million of his own funds in the bank. For our largest banks, with reported capital levels over 50 times larger than my hypothetical mid-sized bank the CEO would have to invest over $20 billion. Myerson’s model is literally impossible because there are not remotely enough multi-billionaires with great managerial competence to run our largest firms, and many of the wealthy are not managers. Myerson’s model predicts, therefore, that there will be endemic “bad” behavior by CEOs who are not sufficiently wealthy to be amenable to Myerson’s optimal bribes to “imitate” good CEOs.
In his eagerness to proclaim his paean to plutocracy, Myerson did not even consider the negative consequences of plutocracy for the world and for his models and policies. For Myerson, plutocracy is all positive.
“Proponents of the free-market system do not advocate it merely as an excuse for abandoning egalitarianism. The free market distributes economic power and rights to people throughout the population, and so the free market may be seen as the antithesis of centralized political control of the economy.
From this perspective, we may try to derive the rationale for the free market from a model where centralized political control causes economic inefficiency. The costs of unrestrained central power can be understood as problems of moral hazard at the center of government” [p. 337].
Myerson seeks to transmute the dross of plutocracy into the gold of pluralism and democracy. The great danger is the “unrestrained central power” and the resultant “moral hazard at the center of government.” Plutocracy is Myerson’s answer to countering the evils of governmental “power” and preventing “economic inefficiency.” Once more, capitalism is unique because it is the only system guaranteed to produce enough multi-billionaires to prevent the democratically-elected government from causing “economic inefficiency” and securing excessive “power.” Myerson’s lecture supports the later claim by Lloyd Blankfein, Goldman Sach’s CEO: we owe our economy’s success and our democracy’s success to the genius, guts, work ethic, and wealth of the top one-one-thousandth of one percent – the multi-billionaires, made wealthy through the shareholders’ bribes to “imitate” “good” bankers – who truly are doing “God’s work.” For Myerson, democratic government is bad and plutocrats are good. Plutocrats are the only ones that can save democracy from the tyrannical “power” of the democratically-elected officials.
In Myerson’s December 2012 presentation of his model that would purportedly contain moral hazard, he made a naïve claim about control frauds.
“Agents in a firm might look to state courts for contract enforcement, but not in a political faction that acts to take state power itself.
Political leaders are highest guarantors of social incentive systems (emphasis in original).”
Political leaders acting in alliance with the plutocrats who funded their rise to power are the “highest guarantors” of “anti-social incentive systems” that will enrich the plutocrats and their political patrons at the expense of the public. This is the defining trait of crony capitalism. Plutocrats place their central reliance not on laws and contracts but on their political patrons. Plutocrats have the ability and the incentive (and no upsetting mores) to aid their political allies “to take state power” and become the “highest guarantors” of the perverse incentives that define the dominant strategy for crony capitalists and their political co-conspirators.
Myerson operates in such an ethics-free zone that he suggests that if we only sold political offices to the highest bidder we would create the correct incentives in the public sector because:
“Candidates would be willing to pay for such highly rewarded offices.” Buying and selling political office is an infamous practice known for millennia. It is typically a felony in the United States, as Illinois Governor Blagojevich learned. Like simony, which included the sale of indulgences, the actions bring the institution into public contempt and create endemic corruption.
Myerson expands on his ode to crony capitalism by developing a metaphor about “courtiers.”
“To build a state, a leader must solve this central moral hazard problem of binding himself credibly to reward past service.
Solution: organize top supporters in a court or council where they monitor his distribution of rewards and offices, as they serve him. [My APSR ’08]
The leader’s personal constitution: keep the courtiers’ collective trust.
Political institutions are established by leaders with reputations for reliably rewarding good service by supporters in a network of patronage” (emphasis in original).
Like the 19th-century socialists, we may dream of great social reforms.
But we should understand that the institutions of any such brave new world would be built on narrower factional foundations, organized by political leaders whose first imperative is to maintain their reputation for rewarding loyal supporters” (emphasis in original).
Myerson does not mention the obvious interconnection of his paean to plutocracy, his model that makes the wealthy vastly wealthier, and his model of government. The plutocrats’ political minions’ “first imperative is to maintain their reputation for rewarding loyal supporters” – the plutocrats. That is precisely the problem – the politicians’ “first imperative” is “rewarding” the plutocrats who put them in office. The dominant plutocrats are in finance. The economic result of crony capitalism is that the financial “markets” become so perverse that the CEOs leading control frauds prosper and the result is a terrifying financial crisis. Tens of millions of people are left unemployed and the losses (at peak) are far in excess of $10 trillion. The results for our democracy are shameful – leading to the obscenity that a Nation in which no one is supposed to be above the law now has a doctrine of “too big to prosecute” for our most elite and most fraudulent financial leaders who caused the financial crisis and were made wealthy as a result of leading control frauds. This is the twin travesty of economic and political ruin via plutocracy and crony capitalism that Myerson praises. We give Nobel prizes to the scholars whose predictions have failed and whose policies have proved disastrous at the very time that their policies are crushing the financial system and enshrining crony capitalism.