An economist’s defense of the world’s tycoons and the businesses they build

Caroline Freund in her Washington office.
Caroline Freund in her Washington office.
Image: Caroline Freund
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Does economic development depend on a class of super-wealthy tycoons? And is that such a bad thing?

In her book Rich People, Poor Countrieseconomist Caroline Freund says yes and no. As a former World Bank official in the Middle East, she saw countries wracked by crony capitalism—but also knew that some countries had succeeded in sharing prosperity alongside a class of new billionaires. Digging into the data while serving as a senior fellow at the Peterson Institute for International Economics, she found out what makes for good Tycoonomics: Access to the global market.

Quartz recently visited Freund to talk about her research. The transcript of our interview has been condensed and edited for clarity.

How did you get interested in the role of these tycoons in development?

In my work in trade, we went kind of from looking at aggregate data to looking at firm-level data. What we found is that individual firms really matter. You look at the top exporter in a country, and a small or medium-sized country, the top exporter tends to be about 15% of exports. The top five exporters are a third of exports, and an even a bigger portion of export growth and diversification. Really large individual firms matter a lot.

Then, the last couple years, I was at the World Bank. I was working on the Middle East and North Africa. I started right as the Arab Spring was unfolding, and the issue there was, “Oh, this crony capitalism is a disaster. Why is it so bad?” And I kept thinking, crony capitalism is terrible, but a lot of countries have done really well with cronies: Korea, China to some extent, Indonesia. What’s the difference in the Middle East?

I came to the conclusion that it’s about the incentives. If the incentives for the cronies are to compete internationally, they have to produce something that is a good product, and they have to produce it very efficiently, or it’s not going to be globally competitive. In the Middle East, you had the crony regimes, but they were focused on raising border barriers and selling to their own public. Then, it’s all about monopoly power and regulations and keeping other businesses out.

What activities are most well-rewarded in a country will tell you a lot about the type of incentives in that country for business. See who the richest people are, and that will tell you exactly what activities are well-rewarded.

So that’s what you did.

What we did, and I did this with a research analyst, Sarah Oliver, is we researched the Forbes billionaire list, and added some variables about how [the people on it] made their money, whether they were inherited or self-made, were they a company founder or executive, were they politically connected? Or privatization based? [We looked at] all kinds of people whose wealth is somehow tied to a special relationship with the government.

And it really comes out clearly. So in Russia, 75% to 80% of the richest people are either in oil privatization or a married-to-the-Mayor kind of thing. In China, you see a lot of company founders who founded real businesses that sell real products. In Latin America, you see a lot of inherited wealth.

When you think of the history of US industrialization, do you see Tycoonomics at work?

Absolutely—every country that has industrialized has had some form of Tycoonomics, where there are guys out there developing new products, and growing really big firms that sell globally. It happened in the US, it happened in Korea, it happened in Europe, and it’s happening in China, and it happened in Japan as well.

Maybe we can stop shaming big business. There seems to be now, especially in the US, this kind of anti-big business [sentiment]. Other countries are proud of their national champions; I’m not sure why we have to apologize for ours.

On the other hand, there was backlash in the US against the tycoons of the industrial age, which led to anti-trust reform, and today people point to Korean Chaebols as a problem.

I think anti-trust is important; it had been, in the US, when the consumers started to feel like companies were colluding to raise prices. China is developing competition policy now. But to get the process going, especially in smaller countries, openness to trade can serve that purpose.

And that’s not the only incentive that global trade provides.

If you’re a small country, you might be the best producer of water bottles, but you’re not going to sell those water bottles very widely if your population is only a few millions of people. If you have the world population to sell to, you can really grow gangbusters. The other thing is, [trade] incentivizes you into the right areas. So if you’re open to trade, then resources flow to the most competitive sectors, and the most competitive firms in those sectors, just because of the competitive pressures.

If you are open to trade, your firms have to compete with really competitive outsiders, and their big market is going to be somewhere else. The US, China, the European Union as a whole—[there] are kind of special cases where there is an incentive, obviously, to protect your own market.

Are there measures that can help make sure we get the right kind of tycoons?

There are the policies you want in order to encourage these kinds of superstar firms to form and to grow, which are property rights, free entry, and openness to trade.

Then there are policies you want to discourage cronyism, which is more transparent and open bidding for privatizations, competition policy, open government procurement, kind of good governance stuff.

The third [type] is policies to prevent kind of unproductive sources of wealth from creating any kind of social pressures. One clear [example] is the estate inheritance tax. There’s not a heck of a lot of productive activity in receiving a large sum of money or a company because of birthright. You don’t lose too much by taxing that wealth. It also encourages philanthropy, which at least in the US, has done a lot for the country.

How do you see Tycoonomics playing out in India?

India came a little late to the party, in terms of freeing up its markets. They did some really silly things early on. They restricted some sectors for small enterprise only. Well, surprise, those sectors didn’t grow. They’ve since deregulated, and those sectors actually have done very well, so I think they are starting to get there. They have two areas where they have done extremely well, in information tech and pharmaceuticals. And those are precisely the sectors where the regulations have been less daunting.

Were there any findings in your research that surprised you?

<pullquote>They really are the people who are creating the kind of blockbuster firms that employ a lot of people and help a country to grow.</pullquote>I guess the biggest surprise was that [the source of billionaires’ fortunes] was relatively stagnant this year in the advanced countries. Between 2001 and today, the shares have stayed pretty much constant, with about 40% of the population company founders or executives. The big change was the emerging markets, where you see a huge rise in the company founders from about 12-15% to around a third. And then you read their stories, and they really are the people who are creating the kind of blockbuster firms that employ a lot of people and help a country to grow.

What do you think your research implies for organizations that focus on development, like the World Bank?

Because of what happened in the US and some of the other Anglo countries with this rise in the top 1% and 0.1%, there’s this Anglo bias where we think there’s this real danger of this rising elite. That’s a top global concern, and you’ll hear Christine Lagarde make comments like, “The global challenge is inequality,” but with this hint that it’s driven from the top.

I think that’s really misplaced, that we should really be worried about poverty much more. [Inequality] is a problem in the US, I’m not saying it isn’t. But from a global perspective, inequality has actually declined because the Chinas have risen so fast. We should remember that, and also see that it’s not the case that these super rich are growing faster than the wealthy populations in other countries. I think they should continue to focus on poverty, not on the super rich, and [stop] blaming the super rich for all the world’s problems.