The Quiet Coup

Friday, March 27th, 2009

Simon Johnson, a professor at MIT’s Sloan School of Management, was the chief economist at the International Monetary Fund during 2007 and 2008. In The Quiet Coup, he argues that Wall Street long ago “captured” its regulators, leading to a situation not unlike an “emerging” market in crisis:

Typically, these countries are in a desperate economic situation for one simple reason — the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit — and, most of the time, genteel — oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon — correctly, in most cases — that their political connections will allow them to push onto the government any substantial problems that arise.

I largely agree, but I must disagree with one point: the oligarchs don’t run the country like a profit-seeking company in which they are the controlling shareholders; they run it like a profit-seeking company in which they are the management.

Since they are not the residual claimants to the country’s tax revenues after expenses — in fact, there are no such shareholders at all — they have little incentive to grow those tax revenues or to cut expenses. Their goal is not to maximize the country’s profits. But they do have a massive incentive to redirect tax revenues to their friends and families — to create public expenses that provide a private benefit. It’s a principal-agent problem writ large.

A “crisis” that “requires” the government to transfer funds to cronies — pardon, private-sector allies — is just one more acceptable way to extract money from the system. So why try too hard to avoid such a crisis?

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