THE
BEAR'S LAIR The evils of
cronyism By Martin Hutchinson
The awarding but the United States
government of a US$36 billion air 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 it 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 credit default swaps
(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 Federal
Reserve 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 19th century
British essayist and businessman 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 George W
Bush and Barack 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 US 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 US
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 US 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 (compact fluorescent light) 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 US 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 US 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 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 US 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 past 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.
Martin Hutchinson is the author
of Great Conservatives (Academica Press,
2005) - details can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished with permission from
PrudentBear.com. Copyright 2005-11 David W Tice
& Associates.)
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