Extraction Economies & Embedded Pyramid Schemes

Economic theory presumes that people will make rational informed cost-benefit driven decisions. Research in both psychology and behavioral economics shows that people rarely make rational informed decisions. Instead, people make decisions which overestimate the costs and risks of the close and familiar and underestimate the costs and risks of the distant and unfamiliar. (the availability heuristic) [Brockman, Silver, Klein, ] Thus a discussions regarding the trade-offs between close-familiar, and distant-unfamiliar will be critical to understanding our economic dilemmas.

So to understand economic decisions we need to consider the distinction between costs and benefits which are close and those that are distant. Consider four cost-benefit states.

Draft: January 2014

Sections

  1. Costs & Gains - Local vs. Distant
  2. Financial Wealth Extraction Examples
  3. Environmental Wealth Extraction Examples
  4. Summation
 
1. Local gains with local costs is the situation discussed in popular economic theory. People are assumed to make good choices because everything is local and familiar.
2. Distant gains with distant costs constitutes an unusual situation that has more to do with ethics than with economics. *(Frequently activists want something good for other people, but being unfamiliar with the culture and local ecology of those people fail to consider costs of those choices for those people.)
3. Local gains derived from distant costs is an underlying feature of pyramid schemes, corporatism, and industrialization. The easiest way to make large gains quickly is to extract wealth and pass costs to those who are distant. Because this trait is a common feature of industrialization and corporatism it usually gets censored out of discussions on capitalism.
4. Local costs supporting distant gains makes up the counter-part to local gains with distant costs. When one group can transfer the costs of their actions to another place or time, then another group will absorb those costs. Groups do not desire to absorb the costs of somebody else's choices. NIMBYism is thus a natural consequence.

Many of the economic arguments of our era result from people wanting gains without costs while others refuse to accept those costs. One group opposes big box stores or dirty factories moving into their community because they know that the costs for their community will be greater than gains. Another group wants the new industry because they will be among those who realize greater gains than costs (in the short term.) Tragically, many citizens live on both sides of each discussion. They gain from the decisions that pass costs to others, but they don't want to pay the costs especially when other benefit. Below we will look at some examples of wealth extraction common within our corporate capitalist economy.

Definitions:

  • Local: close and familiar, here and now, realized by me and my community immediately
  • Distant: far away in space, time or familiar form, realized by some other people in some other community or some other generation
  • Externality: an uncompensated impact on others
  • Positive-sum exchange: economic activity that increases the wealth of everyone involved
  • Zero-sum exchange: when one gains wealth simply by taking it from others
  • Production economy: the positive sum process of increasing wealth by producing it
  • Extraction economy: the zero-sum process of gaining wealth by extracting it from others or from the environment
  • Embedded pyramid scheme: zero-sum extraction occurring within a production setting
  • Leveraging: using an advantaged position to extract wealth from others

 

 

diagrams representing how wealth extraction can be embedded within exchange
Part 2: Financial Wealth Extraction

Example 1: Employment Hierarchy Pyramid Scheme

Business involves a lot of negotiations. Wealth can be a simple numbers game. If a large corporation has 1 million employees, a CEO can line his own pockets simply by getting each employee to accept 1 less dollar each year. One dollar is a small loss to each employee, but the combined savings constitutes a huge gain for the employer. The employer can repeat this tactic over time, getting each employee to forgo one more dollar each year. In just one decade he can increase his own salary by $10 million with this scheme without ever actually increasing his own productivity. He owes most of his wealth to zero-sum extraction embedded within an otherwise legitimate endeavor.

   

Who gains: executives

Who loses: employees

   
   
Case Study: 2013, Starbucks CEO raked in about $28.9 M while his 151,000 employees made a median wage of $25,500. His "earnings" were more than 1000 times that of his employees. Starbucks executive offices also have a few other highly compensated individuals. With a little arithmetic we can estimate that the few individuals at the top of Starbucks skim more than $200 each year off of every single laborer they employ. $200 might not sound like much, but that is a significant loss to a worker who is only grossing $25,000 before taxes.

Example 2: Direct & Indirect Subsidies Wealth Extraction

Many American businesses receive both direct and indirect subsidies. Direct subsidies include tax incentives given by states or cities to entice the business and subsidies geared towards specific types of businesses such as agribusiness subsidies. Indirect subsidies are harder to identify and track. Big box stores depend on highways and zoning laws that help them locate near highway ramps. These stores depend on high volume traffic and would not be viable if located in low traffic or in-town regions. Thus taxes that support highways benefit big box stores and disadvantage small business. Some companies provide such low pay for their employees that their employees depend on assistance to cover their health care and child care costs. The assistance given to these employees indirectly benefit the company as the workers would have to demand higher wages or leave for other employment without the assistance. The assistance thus benefits the company.

   

Who gains: Executives and owners

Who loses: tax payers & competing businesses

   
   
Case Study: Wal-Mart has received over $1B in identified subsidies. That number fails to account for various indirect subsidies including favorable zoning, highway construction costs and traffic management. It also fails to account for more than $3 B in assistance required by employees who could not afford to work at Wal-Mart's low low wages with it. Thus, roughly 20% of Wal-Mart's $17 B profit is actually the result of various subsidies derived from the taxpayers.

Example 3: Leveraged Takeover Wealth Extraction

Since the mid-1970s leveraged takeovers, corporate mergers, and downsizing have become so common that they are no longer considered news. Yet, from an economic perspective these actions constitute significant news. They are all examples of zero-sum wealth extraction. The players in these actions do not create the wealth they are receiving. They do not exchange the wealth they created for wealth they gain. They simply use an advantaged position to extract wealth already created by others for themselves. In a leveraged takeover no new wealth is created; the wealth already existed within the smaller company. The larger company simply extracts that wealth into their hierarchy. Buyouts are typically followed by downsizing where the workers who built the company lose their wealth. Typically investment value also decreases after the buyout in the long run.

   

Who gains: corporate executives and their lawyers

Who loses: workers & stock holders

   
   

 

Example 4: Risk Costs Transferred to Others

The crash of 2008 should have made this form of wealth extraction obvious to everyone. The news in 2009 was dominated by stories of bankers increasing their own wealth by making very risky choices, then immediately passing the risk to others. We learned new terms like Credit Default Swaps and Mortgage Backed Securities. The initial costs of the bankers bailout was over $700 Billion. But these were only the latest and largest examples of small groups of people scheming to increase their own wealth by passing the cost of their risks to others.

   

Who gains: bankers and their lawyers

Who loses: investors, home owners

   
   
Part 3: Environmental Wealth Extraction

Example 5: Environmental Resource Wealth Extraction

Many businesses depend primarily on the extraction from the environment of resources they never actually created. In many cases government grants those businesses special status to extract the resources from property they never owned, from under other properties, or directly from government property. The businesses are not required to compensate the owners of the land at full market value. Major examples include oil, coal, gas, lumber, and water. Frequently, the extraction damages the properties but the company is never required to compensate those affected for the damages. Damages can include poisoned ground water, habitat destruction, sinkholes, etc. These businesses profit primarily by extracting wealth that would otherwise have belonged to others.

   

Who gains: industry owners & executives

Who loses: home owners & community

   
   

Case Studies:

Example 6: Passing Production Costs Downstream

Much as financial risks can be passed to others, environmental costs of production can be passed to others. Passing environmental costs downstream is the rule for industrialization, not the exception. Many industries owe their wealth to their ability to pass the costs of production downstream in the form of pollution. The losses those downstream suffer may be realized in the form of health risks, water quality loss, air quality loss, and lower quality living environments. Downstream costs occur in both time and space. Many of the environmental costs will be absorbed by future generations. We can think of this as our environmental deficit. Estimates or America's environmental deficit are orders of magnitude larger than America's federal deficit. We should also recognize as a pyramid scheme in that the number of people who must pay will be significantly larger than the number who profited.

   

Who gains: industry owners & executives

Who loses: community dwonstream & future generations

   
   

Case Studies:

Part 4 Summation

The examples listed above are not the only means of embedding zero-sum gains within an otherwise productive activity. They are just the major examples. Other methods are quite common. Zero-sum gains include predatory competition, leveraging, golden parachute, inheritance, and investment strategies that add no value.
The discussion leads us to the observation that most of the super-rich are in positions where extraction and embedded pyramid schemes are common. That raises the question, what is the maximum amount of wealth a person can amass without depending on pyramid schemes or wealth extraction to achieve it? Stated otherwise, what is the maximum wealth attainable from productive work alone? Perhaps the question could be reformulated to, what are the odds that a given income was the result of productive work and not wealth extraction?
The examples above along with anecdotal evidence from the news suggests that the higher the income the less likely that it was acquired without wealth extraction, particularly embedded pyramid schemes.
We can do a quick consideration. Those who invested long hours of creative work producing something that people actually want appear to owe most of their wealth to positive sum gains. The top of list appears to include John Lennon, Ben & Jerry, and J.K. Rowling.
Those who profited primarily from zero-sum extraction includes all those who owe their wealth to inheritance, extraction of fossil fuels or minerals, leveraging, or investment strategies. The pyramid scheme zero-sum gains list includes executives who make more than ten times their employees, executives whose companies depend on government subsides, executives who employed predatory business practices, executives of businesses that dump wastes into the environment, investment bankers who transferred risks to others.
The list of the rich who owe their wealth primarily to wealth extraction appears to be much larger than the list of those who owe their wealth primarily to productive work.

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