Acton Institute Powerblog

Just how bad is crony capitalism?

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The Bosses of the Senate, a cartoon by Joseph Keppler. First published in Puck 1889.

Cronyism is ugly. It hurts the economy, it’s unjust, and corrupts the core of democracy.  “The damage that cronyism has inflicted on the economy is considerable,” Samuel Gregg writes in a new piece for Public Discourse. “[C]ronyism also creates significant political challenges that, thus far, Western democracies are struggling to overcome.”

The crony capitalism seen from the Trump presidential campaign and many others is not something that’s new to America or Western civilization. As long as there have been governments, there have been powerful people seeking special favors from them. From the 17th to 18th centuries, mercantilism “dominated the West,” which involved powerful guilds working closely with their government officials to limit trade and stifle innovation. Gregg explains the cronyism that’s common today:

Today’s crony capitalism is not outright corruption, though it often verges on or morphs into illegal activity. The expression itself first emerged in 1980 to describe how the Philippines’ economy functioned under the Marcos regime. It became prominent in explanations of the 1997–1998 Asian financial crisis, especially the role played in that crisis by government decisions that favored business “cronies” (many of whom were relatives) of political leaders, such as Indonesia’s then-President Suharto.

More generally, cronyism involves dislodging the workings of free exchange within a framework of property rights and rule of law—what is generally understood to be a free market. These arrangements are gradually replaced by “political markets.” The focus shifts away from individuals and companies prospering through freely creating, refining, and offering products and services to consumers at competitive prices. Instead, economic success becomes premised on people’s capacity to harness government power to rig the game in their favor. The market economy’s outward form is preserved (hence, the noun “capitalism” in “crony capitalism”), but its basic protocols and institutions are slowly subverted by businesses seeking to secure preferential treatment from regulators, legislators, and governments. This can take the form of bailouts, subsidies, monopolies, access to “no-bid” contracts, price controls, preferential tax treatment, tariff protection, and special access to government-provided credit at below-market interest rates, to name just a few.

Some businesses enter the market for cronyism to protect themselves against those competitors already trying to use government power to limit other people’s access to “their” markets. The temptation, however, to go from defense to offense is hard to resist. The potential profits associated with rent-seeking are considerable. Moreover, lobbying politicians for favors is often easier than trying to out-compete your rivals through constant innovation and reduction of cost margins.

We’re all “losers” when it comes to cronyism because–economically, politically, and socially–there are many negative effects.

By shifting incentives away from growth through innovation and competition and toward cultivating politicians and regulators, an economy’s overall wealth-creation capacities are undermined. To the extent that cronyism involves introducing more regulations into the economy, efficiency can also be weakened significantly. Another problem is that crony arrangements, by definition, lack transparency. This makes it harder to assess accurately the true costs associated with different enterprises. Just how profitable, for instance, would be the ethanol industry in Iowa if the subsidies secured by Iowan legislators were removed? Could it be that ethanol subsidies are actually blinding many Iowans to what might be their state’s real competitive advantages?

Cronyism’s negative consequences also extend into the political realm. A major example is the injustice of politicians and government officials using state power to confer legal privileges on specific groups in return for their political and financial support. Quasi-authoritarian regimes such as Suharto’s Indonesia used crony arrangements to lock in businesses’ long-term support for the government. As a result, a close nexus was established between the Suharto regime and much of Indonesia’s business community that proved impossible to break, until the 1997–98 financial crisis forced Suharto from power.

Another injustice is that the resources used to pay for crony arrangements come from those who are not receiving preferential treatment. As the Nobel economist Joseph Stiglitz—who is no one’s idea of a fiscal conservative—stated in his book The Price of Inequality, cronyism facilitates an unjustifiable form of income inequality based on the ability of the well-connected to take a larger share of existing wealth than others, instead of creating new wealth through their own work—something that normally would merit them a larger share of this new wealth than those who have not contributed to its growth.

Crony capitalism is pervasive in politics and it hurts everyone, so what’s to be done to stop it? Gregg offers a way to end it:

One solution is the type of economic liberalization that limits opportunities for politicians and government officials to offer the quid pro quo that is central to cronyism. In other words, you constrain the state’s capacity to offer favors by restraining its ability to intervene in the economy. That reduces the incentives for businesses to look to the state for profit through rent-seeking.

Structural change and the alteration of incentives, however, are not enough. Alexis de Tocqueville observed in Democracy in America that institutions matter but mœurs and value-commitments are even more important when seeking to understand why societies—especially democratic societies—go down one path rather than another. At the best of times, many people have difficulty looking beyond their own short-term self-interest. From that standpoint, democracy’s emphasis on regular elections at relatively short intervals creates further complications insofar as governments and legislators become more susceptible to businesses seeking privileges.

All of this underscores one very important point: Unless a critical mass of people (1) cease being acquiescent with or flippant about cronyism, (2) recognize that it is fundamentally unjust, and (3) freely choose and act accordingly, it is hard to stop any political system from gravitating toward cronyism.

Curbing cronyism certainly isn’t an easy undertaking, but it’s a necessary one. Read Gregg’s “Crony Capitalism: Inefficient, Unjust, and Corrupting” in its entirety at Public Discourse.

Sarah Stanley