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The Evils Of Cronyism


Martin Hutchinson

The awarding of a $36-billion tanker contract to Boeing illustrated the well-known difficulties caused by crony capitalism in the awarding of government contracts. However what is less well appreciated is the damaging effect crony capitalism has in a number of other ways, making the economy less efficient and providing rent-seeking opportunities that are both morally and economically repugnant.

Let’s begin with a definition of crony capitalism. In a truly free market, government is small, so gives out few contracts. It also passes few laws that affect business, so for even large corporations there is no point in hiring lobbyists. This was the position in Calvin Coolidge’s America. It still appeared sufficiently true even in the 1990s that Microsoft spent no management attention on Washington lobbying “virtually ignoring the Washington power game” according to the New York Times – and was surprised in 1998 by a massive antitrust suit.

As Microsoft found to its cost (though it survived the antitrust suit and has made up for it since with massive lobbying activities), that is not the America – or world – in which we now live. Crony capitalist companies seek through campaign contributions and strategic placement of their alumni to produce legislation favoring their business, to get access to lucrative government contacts, to rewrite the tax laws in their favor and to create rent-seeking mechanisms whereby their profits (and management bonuses) can be enlarged at public expense.

The costs of crony capitalism became apparent in the 2008 financial crash and bailout. Two episodes stand out in particular. In the rescue of AIG, $62.1 billion of credit default swaps were paid out to counterparties such as Goldman Sachs, who also profited from its holdings of CDS against the credit of AIG itself. Goldman Sachs alumnus Hank Paulson was Treasury Secretary at the time, and appears to have given no significant thought to the possibility of killing the pernicious CDS market by allowing the $62.1 billion in losses to be levied on its major participants.

Second, the banking industry as a whole was energetic in encouraging Fed chairman Ben Bernanke and his colleagues to lower interest rates to zero and to buy over $2 trillion of Treasury and agency securities – decisions that ran directly against Walter Bagehot’s advice for a financial crisis, to lend freely, but at penally HIGH rates. We have not yet seen the full cost of this decision, which has reduced job creation in the recovery to a painfully slow rate (through making labor-saving capital investment artificially cheap), while very probably leading to a major inflationary collapse – and tangentially to the current Middle East turmoil, through the mechanism of excessively inflated commodity prices. Wall Street wanted low interest rates, to bail it out of the mess it had created, so that’s what it got, without regard to the needs of the rest of the economy, the losses to America’s beleaguered savers or the disruption it imposed on the world as a whole. Wall Street alumni being scattered liberally throughout the decision-making process in both the Bush and Obama administrations, it was a classic case of crony capitalism. Again, no proper consideration was given to the Bagehotian alternative

The longest-standing and most entrenched area of U.S. crony capitalism is agriculture. Farm subsidies were introduced in the 1930s and have remained important ever since, with a modest attempt to reduce them in 1996 being reversed by the Bush administration in 2002. In recent years an additional gigantic farm subsidy has been introduced, the corn-based ethanol fuel program. This subsidizes an especially inefficient method of fuel production, which offers no net benefit in terms of carbon emissions – it is a pure handout to the farm lobby, strengthened by the political salience of the Iowa presidential caucuses. Today much of U.S. agriculture is dependent on crony-capitalism controls and subsidies, at enormous cost to the food consumer and the world economy.

The global warming hysteria, as it played out, gave massive opportunities to crony capitalists (whether or not some modest measure of global warming is in fact occurring). Global warming, once it emerged from the academy, was a project of extreme socialist environmentalists to increase government control of the economy. (The academicians themselves became “useful idiots” rewarded with tenure and massive grants in return for proclaiming the global warming religion, adjusting the facts where necessary to justify the theory.) However the movement would not have got far, at least in the United States, without the assistance of crony capitalists.

GE saw the opportunity to close high-labor-cost U.S. light bulb manufacturing plants, relocating production to China, and to reap rewards from manufacturing higher-cost fluorescent light bulbs. Hence it worked with allies in Congress to institute in December 2007 an outright ban on incandescent light bulbs, effective 2012-2014. This measure was costly economically and damaging environmentally, since it failed to solve the disposal problem of the toxic CFL bulbs, which contain mercury.

Crony capitalism also reared its head in the abortive Waxman-Markey cap-and-trade environmental legislation of 2009. Cap-and-trade as a mechanism for controlling carbon emissions is highly subject to capture by crony capitalists, because it inserts the government into an entirely new area of economic activity, and allows it to give out emission permits to favored interest groups. The Waxman-Markey legislation was particularly unattractive in this respect: it imposed a huge new cost on the economy and then managed to lose over 80% of the revenue that should have been received by government through giving handouts to crony capitalists.

Immigration is another area in which crony capitalism is rife; in this case the crony capitalists seek to block proper enforcement of U.S. immigration laws in order to ensure themselves a labor supply at below-market costs. As with the “cap-and-trade” scheme the crony capitalists are here seeking to distort the legal system and the market mechanism to achieve self-enrichment through government manipulation. The current dispute in Georgia is a case in point; Governor Nathan Deal, elected on a platform of enforcing the e-verify employment verification program, appears to have bowed to crony capitalists among his campaign donors and is now seeking to block the appropriate state legislation.

Crony capitalism is rife in the taxation system, as businesses seek special exemptions from taxes that apply to the remainder of their countrymen. The subsidies to GE and Whirlpool for making energy efficient washing machines, which appear to have wiped out a decade or so of the latter company’s tax liability, are a case in point. Another example is the “carried interest” taxation of private equity funds, whereby the tax code deems their bonus remuneration to be a capital gain, even though no capital has been invested.

Of all areas in the U.S. economy, crony capitalism is most rife in the health system, which is why healthcare costs 50% more in the United States than elsewhere in the world. Hospitals are encouraged to load their non-insured customer with additional costs arising from their enforced mandate of providing free care in emergency rooms. An entire industry of medical care trial lawyers exists solely to leech off the medical system, using their political connections to ensure their protection rackets are preserved unharmed. The pharmaceutical companies load their drug development costs onto U.S. consumers, protected by legislation prohibiting drug purchases from abroad. The examples are innumerable; the costs loaded onto the healthcare dollar are becoming unsustainable. Needless to say, President Obama’s healthcare legislation, heavily supported by many producer interests in the healthcare sector, made none of the cost reductions that had been promised, simply adding a new layer of bureaucracy, cost and controls to an already overloaded system.

The above examples should indicate that crony capitalism has become a major burden on the U.S. economy. Through it, government meddling is proliferated, spurious costs are added and politically connected producer interests are given windfall profits. The problem has steadily worsened since the abandonment of small-government free enterprise in the Great Depression, and the proliferation of new excuses for regulation in the last few decades has provided endless new opportunities for crony capitalists, greatly increasing their burden on the economy.

The solution is not merely smaller government but less intrusive government. To the extent that laws are simple, comprehensible and properly enforced, the opportunities for crony capitalism are limited. Environmental controls need to be cut back to those that truly produce a net economic benefit, after taking into account the health and other costs of pollution. Immigration laws need to be simplified, with fewer loopholes such as H1B visas and the lottery program, and enforced strongly and equitably. The financial system needs to control excessive speculative activity, through a modest “Tobin tax” on fast trading and a bank regulatory system that enforces proper risk management as well as simply capital standards. Frivolous lawsuits, cross-subsidization and excessive regulation need to be removed from the healthcare system so the free market can operate in medical services, while the poorest are protected through handouts. Loopholes must be removed from the tax system, not only in corporate tax but also in individual tax – the “sacred cows” of the mortgage interest deduction and the charitable contributions deduction must be abolished.

The necessary changes will provoke immense squawking from the interests concerned. But in economic legislation there is a universal aphorism: the loudest squawks come from those whose unjustified privileges are to be abolished.

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One Response

  1. Thank you for this interesting article…

    The Darker side of the push to use CFLs:
    How manufacturers and vested interests have pushed for a ban on
    popular regular bulbs,
    and lobbied for CFL favors – with happy political cooperation:
    http://ceolas.net/#li1ax
    with documentation and copies of official
    communications

    In my view, all lights have their advantages -after all, that is why
    they are on the market for people too choose –
    none should be banned:
    and this is a ban,
    since bulbs not reaching the standard will be disallowed. Halogens
    have construction and light output differences to regular bulbs, as
    well as costing much more, for the marginal savings obtained.
    LEDS are not yet suitable or attractively priced for bright,
    non-directional general use:
    Hence the push for people to use CFLs, as described …

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