10 June 2015

It isn’t ‘Billionaires vs. the People’

By Jan Svejnar

When I escaped communist Czechoslovakia in 1970 and enrolled at Cornell University, I was taught that becoming a billionaire was impossible – the American dream was over. The last few decades have proved this thesis from my introductory sociology course wrong.

In fact, two kinds of major economic transitions in recent years produced more and more billionaires.  The first is the post-Communist transition that started after the fall of the Berlin Wall in 1989 and the launch of China’s reforms in 1978.  Their challenge has been to supplant a centrally planned economy with a modern market-based economy.

The second transition concerns the growing levels of income and wealth inequality in many countries around the globe.  In particular, the top 1% of the population will soon hold over one-half of the world’s wealth and the share is growing. Interestingly, in the communist countries, incomes and wealth holding were quite egalitarian, but over time has become more and more unequal, especially in Russia and China.

An important way to improve our understanding of these issues is to examine the economic role of billionaires and what their accumulation of wealth means for the rest of us. Sutirtha Bagchi of Villanova University and I have done exactly that. Applying econometric techniques to data on billionaires published by Forbes magazine we find that a greater presence of billionaires in a country slows down its economic growth.

In other words, controlling for other relevant factors, we demonstrate that countries could grow their economy faster if there was less money controlled by the uber-rich. This implies that economies could be more efficient if more money were allocated by others than those at the top of the pyramid.

We also stress that the sources and nature of inequality must be taken into account.  Indonesia and the United Kingdom for instance have a similar value of the most widely used indicator of income inequality (Gini), but they differ markedly on the role that political connections play in achieving economic success and distribution of income and wealth.

Broadly speaking, billionaires come in two types – those who would not have made it without political connections (the political cronies) and those who became billionaires because of their ingenuity, ability to innovate and willingness to take risk (the politically unconnected). The two types may have very different effects on performance of countries. While politically connected billionaires may be found in many countries, they are disproportionately represented also in the post-communist countries, including Russia where many emerged as political cronies of Boris Yeltsin.

Dividing the world billionaires into these two categories, we were careful to assign the politically connected category only to the most clear-cut cases, such as the Yeltsin-related oligarchs or Suharto-related nouveau riches, while counting the Bill Gates and Warren Buffet-style wealth as belonging to the innovation (politically unconnected) category. What we discovered is the effect of politically connected billionaire wealth on growth is strongly negative, whereas the effect of politically unconnected billionaire wealth is indistinguishable from zero.

That means that billionaire cronies constrain economic growth, while billionaires who aren’t cronies on average don’t do so.

Why are these findings important for the rest of us?  They indicate that public policy toward income and wealth distribution needs to take into account the nature of wealth accumulation. They also relate directly to the findings of economists like Stiglitz and Picketty, who predicted that the rich will get richer faster, which has proved true, and that we ought to develop tax policies that prevent the poor from becoming ever poorer.

Jan Svejnar is Director of the Center on Global Economic Governance and James T. Shotwell Professor of Political Economy at Columbia University. He is the co-founder and chairman of the Executive and Supervisory Committee of the Center for Economic Research and Graduate Education (CERGE-EI), Prague.