The Origin Of Inequality is Political by Vuk Vukovic, PhD

If a board member of a company is politically connected, on average he has a $150,000 higher salary than a board member who’s not connected. Politically connected executives reap direct benefits for their companies based on their connection, in the form of favorable regulation or direct government contracts and get rewarded for it. Politicians on the other hand get campaign donations or cushy board positions after their careers.

This is what means to be a part of an elite network: an informal relationship between friends and acquaintances on positions of power, which exchange favors between each other, whilst creating negative social consequences - in particular increasing income inequality.

In my new book, Elite Networks: The Political Economy of Inequality, I argue that the most important overlooked cause of inequality is the misuse of political power.

Inequality has been present in our societies ever since the Agricultural Revolution. It’s not a modern phenomenon, nor is it tied to one economic system. Ancient civilizations, feudalism, capitalism, socialism - all these systems have had (at times or permanently) very high levels of wealth concentration at the top, and misery for the rest; however, unlike today, in pre-Industrial Revolution times, widespread poverty was a constant.

How did people get rich back then? Violence. You either had the legitimacy to use violence - being a ruler, part of nobility or clergy - or you went to wars because you were promised to keep the pillage. This is indeed how every noble family made their fortune at one time in their history, through violent conquest.

Today, especially after the second half of the 20th century, we experienced an unprecedented increase in societal wealth and living standards. Today, people can get rich with their own ingenuity, hard work, and competence. In other words, without violence, even though it persists as a motive.

However, inequality also persists. We changed so many social orders and finally made ourselves, on average, rich as a human race, but still, we get unequal distributions of wealth, incomes, and opportunities.

Naturally, many of these inequalities are due to some people simply being better at what they do; more innovative, more special than others. This is particularly observable through the superstar effect, or even the influencer effect. Others are competing on the global market, so their compensations are necessarily higher than wages of workers in the local market.

Vuk Vukovic, CIO and Co-Founder of Oraclum Capital

The real issue, however, is not differences in income based on innovation or talent. The real issue is the misuse of political power to get ahead and achieve wealth. Differences in outcomes based on proximity to power.

This is encapsulated through elite networks – informal relationships between politicians in power and owners of capital or corporate executives. The ties between them imply that executives use their friends in politics to get direct benefits for their firms, for which they get rewarded with greater compensation. Politicians get campaign donations, or board positions, or an outright kickback.

How does this get translated into higher inequality? The inequality literature explicitly says that top 1% and top 0.1% income earners are most responsible for the huge earnings differences between the top and the rest. Corporate executives are the bulk of this group, particularly the top 0.1%. If a large part of their higher salary and bonuses is tied to their political connections, it’s clear where the root cause of inequality lies.

This is the real issue in contemporary democracies. When elites misuse political power to get an advantage, to get access to information or opportunity, and when corporations seek protection via the political process. It’s very important to understand this difference.

Think of Big Tech firms. No doubt they achieved their status and market dominance thanks to their innovations and the network externality effect. But now, when voters and policymakers want to limit their power – e.g. usage of our private data and algorithms that can anticipate our behavior better than ourselves - their response is to infiltrate into elite networks. They hire former politicians and utilize their networks to lobby favorable regulation. This leads to huge between-firm differences. Research has shown that the highest paid positions are clustered in a handful of the most powerful corporations. And these corporations tend to get stronger and stronger by seeking political protection.

Innovation made them rich and powerful, and they deserved it. But now a different phase of the life cycle begins - preservation of status through the misuse of politics. Innovators are turning into rent seekers.

Knowing that long-run forces driving inequality were always rooted in extractive political power means a complete reimagining of its solutions. Don’t increase centralized power, that only worsens the outcome. Similarly, taxing the rich merely deals with the consequences. A top executive will benefit from proximity to political power regardless of their top marginal tax rate.

If we wish to truly lower inequality and prevent incentives of elite network formation we must first 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. Achieving that is easier said than done.