Seven years on, the corporate bailouts of the late-Bush-early-Obama years remain deeply unpopular. Though Dodd-Frank was supposed to have killed it, the “too big to fail” designation, which allows some firms to benefit from the expectation of a rescue, lives on under a different name. Now we call them Systemically Important Financial Institutions, or SIFIs.
SIFIs are emerging as an early issue in the 2016 presidential race, and this is in many ways a reflection of the public’s growing suspicion of the unhealthy alliance between business and government. But nothing captures this weariness better than the suspended animation of the Export-Import Bank (which goes by yet another acronym, Ex-Im).
For the first time in its 81 year history, this federal agency which doles out taxpayer-backed subsidies to foreign firms that buy from American exporters (and, occasionally, directly to the exporters themselves) has lost its congressional authorization. As I have explained in this video, and as my colleague, Veronique de Rugy has exhaustively demonstrated, the bank’s suspension is good for the economy. The agency’s costs — foisted on taxpayers, consumers, and borrowers — far exceed its benefits — mostly concentrated on ten highly successful, very large corporations.
But it is also good for the body politic because it shines a big bright spotlight on what may be the worst aspect of 21st century democratic-capitalism: the tendency for businesses to obtain lucrative privileges from government. As I wrote in 2012, this sort of privilege “misdirects resources, impedes genuine economic progress, breeds corruption, and undermines the legitimacy of both the government and the private sector.”
Though economically and socially destructive, corporate privileges are stubbornly difficult to uproot. A host of political scientists and public choice economists have demonstrated that policies which concentrate benefits on the few and spread costs across the many tend to stick around. But what do we call this phenomenon?
An issue of terminology
How we choose to label a problem often dictates how we attempt to solve it. Unfortunately, the growing entanglement of government and business is typically mislabeled. From “mercantilism” to “corporatism” to “crony capitalism,” none of these words accurately capture the problem at hand. They cause us to talk past one another rather than with one another. And worse, they encourage the pursuit of bad solutions.
When Adam Smith and other classical economists took on the task of defining the problem, they called it “mercantilism.” But most of us who learned this term (around 8th grade) forgot its meaning by the end of our high school senior trip. And there is good reason for this: the term is outdated, awkward, and does little to describe the problem in any way a general audience would understand.
Mussolini, who made the marriage of state and private enterprise a centerpiece of his economic policy, called it “corporatism.” Thus, Saifedean Ammous and economic Nobelist Edmund Phelps have argued that “corporatism,” rather than “capitalism” is a better word for the problems playing out in our modern economic order. Perhaps. But corporatism isn’t particularly descriptive either. And its association with the fascists may connote racism (it is a costly and socially destructive force but it would be unfair and inaccurate to call it racist).
By the 1970s, many were calling the public promotion of particular corporate interests “corporate welfare.” I have no strong objection to this term. But it is interesting to note that it seems to gain currency with whatever party is in the minority. And invariable, it is dropped like a bad habit once that party ascends to the majority.
During the Asian Financial crisis of the late 1990s economists and journalists began to use a new term: “crony capitalism.” It captures the fact that in many countries, financial success depends on whom you know, and not on whether you create value for customers. The term crony capitalism seems to have stuck. It is used to describe everything from bailouts, farm subsidies, and Ex-Im, to “economic development” grants and loan guarantees to the likes of Solyndra.
Why “crony capitalism” isn’t the problem
The term “crony capitalism” is invariably used as a pejorative. And like corporate welfare, has become a sort of shorthand for “a program I don’t like.” Some have complained that the phrase unfairly tarnishes “capitalism” and prefer to just go with “cronyism.”
But neither “cronyism” nor “crony capitalism” really capture the phenomenon. Not being particularly descriptive, these words fail a basic function of language, which is to give us a common understanding. So what looks like crony capitalism to one, may look like a legitimate government program to another.
What’s worse, in missing the mark, these terms encourage well-meaning reformers to shoot the wrong targets.
Let’s start at the roots. Cronyism derives from the Greek word “chronios,” as in time. It originally referred to those we’ve known for a while, our chums. But today it is typically associated with special treatment toward our old chums.
Special treatment of a chum is sometimes a bad thing. But this isn’t always the case.
In many private setting, special treatment of friends is good. Every day we hire, date, and freely associate with people on the basis of our friends’ recommendations. Years of repeat dealings have taught us that these people are to be trusted (that, after all, is why they are our chums). And what could be more natural and good than to treat those whom we know and respect as “special”?
Here is a more reliable rule of thumb: it is typically bad to use other people’s resources to give our chums special treatment. A manager who hires an unqualified buddy is wasting company resources. And a mayor who awards a contract to a ne’er-do-well brother-in-law is wasting taxpayer resources. Since public officials are always using other people’s resources, this rule of thumb should be a warning to all those in public office.
But if you think of ExIm and Too Big to Fail, the Farm Bill and Solyndra, none of these examples of crony capitalism necessarily deals with cronies. Yes, ExIm officials have been under investigation for steering subsidies toward companies that gave gifts and kickbacks. But ExIm subsidies are economically inefficient even when they don’t go cronies. Yes, Obama Administration officials seem to have had close ties with Solyndra executives. But green energy subsides (begun under President Bush) are socially costly even when they go to perfect strangers.
Plenty of farmers benefit from economically wasteful agriculture subsidies without knowing anyone at the Department of Agriculture. Lots of movie executives profit from state film subsidies without knowing the governors and legislators who privilege them. It’s a safe bet that a good number of taxi drivers know none of the mayors and city councilors who protect them from sharing economy competitors. Each of these policies is emblematic of the problem with modern democratic capitalism, but they really have nothing to do with “cronyism.”
Ironically, public choice models suggest that the economic cost of privilege-granting (economists call it “rent creation”) is actually greatest when there is no crony relationship. The reason is simple: if everyone knows that the brother-in-law is going to get the contract, then no one bothers wasting resources pursuing it. If, on the other hand, the mayor says he plans to give the contract to the highest bidder, then lots of resources will be sunk into seeking it. (To put this in technical terms, the costs of rent seeking rise as the rent-seeking contest grows more competitive).
It’s the favoritism, stupid
The chronios part of “crony capitalism” is not the problem. It’s the favoritism.
If the mayor’s brother-in-law happens to be the best street sweeper in town, he should get the contract. The important thing is that he not be allowed to skip the competitive bidding process; he shouldn’t be singled out for special treatment.
As I explain in that 2012 piece, special privilege undermines competition. It encourages firms to ignore both costs and customer desires. It causes real resources — time, money, and effort — to be wasted in rent seeking. It slows growth by incentivizing talented people to become unproductive entrepreneurs rather than productive ones. It sews the seeds of macroeconomic instability by misallocated resources. It even undermines the legitimacy of government and business.
Those who think the problem is simply about cronies — about relationships — are likely to call for misguided and potentially counterproductive solutions. They’ll think that something as trifling as a one year (or even a lifetime) ban on lobbying by former legislators and legislative staff will solve the problem. But there are other means to persuade. If they can’t employ former colleagues to prevail upon current policy makers, firms will donate to PACs; they’ll fund independent advertisements; and they’ll sponsor get-out-the-vote efforts. They’ll make products that policymakers, rather than customers, value. And they’ll make them in costly ways (for example, by employing resources in politically important districts).
Of course, well-meaning reformers will want to go after these efforts too. But at best, this will lead to a fruitless and endless game of whack-a-mole. And at worst, it’ll snuff out the freedom that permits these activities (Madison, in Federalist 10 was on to something: “[I]t could not be less folly to abolish liberty, which is essential to political life, because it nourishes faction, than it would be to wish the annihilation of air, which is essential to animal life, because it imparts to fire its destructive agency.”). In a free society, we need to be able to talk to our elected officials, to sponsor advertisements critical of them, and to organize get-out-the-vote efforts.
As long as policy makers have the ability to privilege particular firms, particular firms will have an incentive to seek those privileges. Water flows downhill. Incentives matter.
But in the long run, ideas — the economist/philosopher/historian Deirdre McCloskey would say words — trump even incentives. If we focus on the right words — an end go all forms of favoritism in public policy — we can change these incentives.
