Mar 16, 2020
Cronyism: A Toxic Friendship between Business and Government
When the government’s rules favor incumbent firms at the expense of current and potential competitors, we all lose.
Free markets are incompatible with crony capitalism—the practice of businesses lobbying governments for, and governments granting them, special favors in the form of monopolies, subsidies, tax credits, low-interest loans, or regulations that prevent new firms from entering the field and competing with the favored businesses. Progressives and conservatives sometimes object to crony capitalism on the basis of which industry or firm is getting the favor. As a rule of thumb, Progressives approve of favors for anything green-ish, conservatives for anything militaristic. Both love favors to “our family farmers”—even though nearly all the farm aid goes to big farmers of cash crops. Libertarians alone object to government favors in principle.
Causes and Effects of Cronyism
Crony capitalism is prevalent at the federal as well as the state level, where occupational licensing creates a virtual monopoly of established businesses by requiring expensive licensing procedures for newcomers. Cronyism is thus both unjust and harmful. By boosting the profits of some industries or firms at the expense of other industries or firms, the government violates its obligation to treat everyone impartially, and harms the disfavored industries or firms. And since the government plays favorites by dipping into the public coffer, it also harms taxpayers. The practice socializes costs while privatizing benefits. Crony capitalism also breeds corruption in both business and government, because in exchange for government favors, firms spend money on the campaigns of the favoring politicians. Last but not least, the practice also costs society billions of dollars in unrealized prosperity by harming the privileged firm’s competitors or preventing would-be competitors.
All in all, in Matthew Mitchell’s words, cronyism is an “extraordinarily destructive force.” (Matthew Mitchell, The Pathology of Privilege). Big business is usually regarded as the worst culprit in this regard. But some researchers point out that at least currently, big business doesn’t have much influence on the federal government, as measured by the amount it spends on lobbying: $3 billion a year, versus the $300 billion spent on advertising. (Tyler Cowen, Big Business: A Love Letter, 170-71). But how much big business spends on lobbying might not be a very good measure of its influence on government policy. Perhaps it spends relatively little on lobbying because it doesn’t need to spend more to get what it wants. Even if that is the case, it may still be true that most big, privileged firms don’t have much influence on government because we live in an era of fast technological advances. As a report by Credit Suisse analysts claims, “The average age of a company listed on the S&P 500 has fallen from almost 60 years old in the 1950s to less than 20 years currently.” (“Technology killing off corporate America: Average life span of companies under 20 years”)
On the state and city level, however, attempts by established businesses to keep out new competitors have led to the expansion of occupational licensing. Whereas in the 1950s, only 5% of workers had to be licensed to practice their profession, now nearly 33% do. (License to Work: First Edition, Executive Summary) And many of the licensing requirements have nothing to do with consumer safety.
To be clear, not all business lobbying of government is for the sake of special privileges. Some of it is for the sake of preventing or changing harmful or unjust regulations. The epithet ‘cronyism’ applies only to the former. Again, not all businesses that engage in cronyism are equally at fault. And some may not be at fault at all. Consider a business that seeks a tax credit or subsidy purely defensively, that is, only because it can’t compete against businesses that are getting tax credits or subsidies. No business—or person—has an obligation to do what would normally be obligatory in a corrupt system or situation, if doing so means harming, or even destroying, itself. Not seeking the same favorable treatment as one’s competitors in this situation would be like playing by the rules in a game where everyone else is cheating. A business that seeks a tax credit or subsidy defensively, however, will stop taking tax credits or subsidies when it no longer needs them. If it doesn’t, then it joins the long list of firms that seek favors just for gaining an advantage over their competitors. Needless to say, a business that is already flourishing has no excuse for trying to get tax credits or subsidies. This is what makes Amazon’s recent successful attempts at such help for its second headquarters so deplorable.
Some libertarians reject the idea that seeking tax credits is cronyism because, they claim, the state never had a right to impose taxes on us in the first place. Whatever the merits of this claim about taxes, the argument proves too much. If it’s ok to seek tax credits, it’s also ok to seek subsidies, because, after all, subsidies are taken from the same taxes that the state supposedly never had a right to impose on us. Similarly, if it’s ok to seek tax credits, it’s ok to seek low-interest or guaranteed loans from the government, because they also draw on the taxes that the state supposedly never had a right to impose on us. So if seeking tax credits is not cronyism, neither is seeking subsidies or guaranteed loans, a view that libertarians, of course, reject.
It’s important to note that a business that doesn’t get government help when its rivals do needn’t always do worse than its rivals. Sometimes the exact opposite is true. For example, J.J. Hill’s Great Northern Railroad was the only transcontinental railroad built and operated without any government help. It was also the most successful. The two facts are connected. Because he wasn’t subsidized, Hill built his track only where he expected people to use his railroad, whereas his subsidized competitors laid track willy-nilly, as Congress was paying them per mile of track. (Folsom, Myth of the Robber Barons.) Hill educated his farmer-customers about the latest agricultural technology and methods, because he could prosper only if they did. Most of the subsidized railroads went bankrupt in the panic of 1873. Hill’s Great Northern Railroad not only survived, it was, according to the biographer, Michael P. Malone, the “best constructed and most profitable of all the world’s major railroads,” even as the rates Hill charged fell steadily with greater efficiency. (“Railroads, Robber Barons, and Unbridled Capitalism”)
Similarly, Commodore Vanderbilt’s steamship business flourished without any government help, whereas its rivals, fattened by subsidies, foundered under the weight of their own incompetence and wastefulness. (Folsom, Myth of the Robber Barons) In the 1830s, Vanderbilt established routes all over the Northeast, offering service that was cheaper and faster than that of his competitors. Everywhere he went, he reduced fares permanently, beating out Robert Fulton, who had been given a monopoly by the New York State legislature for thirty years. Because Vanderbilt had only his wits to help him compete against his subsidized rivals, he came up with ways of cutting costs and wooing passengers that made his steamships by far the most popular. He also competed with a subsidized trans-Atlantic steamship run by Edward Collins, who got lavish subsidies that were spent on luxurious and economically inefficient steamships (6-8). Vanderbilt declared that his own prosperity was “the direct result of unfettered trade, and unrestrained competition,” and that it was his wish that those who came after him would also find an open field (7-9).
Whom to Blame?
As is obvious, cronyism is both harmful and unjust. Who is primarily responsible for it? Who is the prime mover: the business that lobbies for subsidies, tax credits, tariffs, low-interest loans, or regulations to prevent competition, or the government that grants these favors? A long line of economists, all the way from Adam Smith in the 18th century to Milton Friedman in the 20th, have criticized business for seeking favors. These days, libertarians and others who defend free markets tend to blame the government, whereas progressives, when they blame anyone, tend to blame business.
One reason that most libertarians assign the major share of the blame to the government is that the government violates its obligation to be impartial by playing favorites. This is certainly true. But doesn’t business also have a moral obligation to compete fairly in the market, instead of seeking special treatment? Some libertarians argue that the only obligation of business is to maximize shareholder value without deception or fraud. But avoiding deception or fraud is not sufficient. As Milton Friedman points out, a business must increase its profits within “the rules of the game,” and the rules not only bar deception and fraud, they also require “open and free competition”. Crony capitalism is the very antithesis of open and free competition.
A second reason that libertarians hold the government primarily responsible for cronyism is that if government didn’t have the power to intervene in the economy, business couldn’t lobby it for favors. The root of the problem, they say, is that government has arrogated to itself the power to intervene in the economy. This complaint is also true. But has government accrued this power all by itself, without any encouragement from business? This seems doubtful, if only because government agents and businesspeople have the same incentives to grow the government’s power of intervention. Each wants something from the other, and each is willing to trade favors to get it.
A third reason why libertarians point to government as the main culprit is that however this unhappy state of affairs came about, government, and only government, has the power to change it by changing the laws that allow the government to intervene in the economy. This is undeniable. But those who want to change these laws cannot become government agents without the support of voters. Unfortunately, libertarians seem to be the only group that support such reform-minded individuals. Too many businesses support politicians who will pass regulations that will protect them from competition. And too many non-business voters think that all regulations protect customers from harm, or else that they serve social justice. Their guiding philosophy seems to be that “it is to secure these regulations, that Governments are instituted among Men”; without these regulations we would be like helpless children in the hands of business. As libertarians and other defenders of free markets know, however, most federal regulations benefit big business at the expense of small or new businesses, and occupational licensing at the state and local level often protects established businesses at the expense of new ones. Sadly, even the most obviously ridiculous regulations and licensing requirements are welcomed with open arms by many voters. Consider the federal regulations of frozen, unbaked cherry pies. The FDA requires that all such pies contain at least 25% of cherries by weight, of which no more than 15% may be blemished. It further defines “blemished” and “frozen” and tells bakers how much crust they may have on the pie. Fortunately, the FDA recently announced that it would axe this regulation (“FDA To Stop Regulating the Amount of Cherries in Frozen Cherry Pie”). But when I posted this announcement on Facebook, the news was greeted with alarm by some of my friends, as though without this regulation frozen cherry pie aficionados would forever more be condemned to eating pure flour pies instead of cherry pies. Yet the unregulated condition of blueberry and other fruit pies occasioned no alarm.
It seems that there is no one primary culprit in the picture. Government, business, progressives, and conservatives are all equally blameworthy. The government is more at fault when it takes the initiative to offer subsidies, tax credits, or loans to a business or industry. This may be the case with the electric car industry. A particular business or industry is more at fault when it takes the initiative to lobby for favors. Conservatives are more at fault when they push for subsidies for manufacturers of military equipment. And progressives are more at fault when they demand more regulation of businesses.
The Way to Open, Competitive Markets
Is there a way out? Michael Munger and Mario Villarreal-Diaz are pessimistic (“The Road to Crony Capitalism”). Businesspeople have to act rationally, they say, and it would be irrational for them to leave dollars on the table (p. 341). Likewise politicians vis-à-vis votes. But what is rational or irrational depends on your goal. If your goal is to make money any old how—or be elected any old how—then Munger and Villarreal-Diaz are right that rationality requires businesspeople—and politicians—to keep playing the crony game. Yet, as we have seen, there have been and still are some businesspeople (e.g., Whole Foods founder John Mackey and former BB&T CEO John Allison) whose goal is to make money only in free and fair competition. And there are politicians whose goal is to treat everyone fairly (e.g., Justin Amash). For all of them, cronyism is irrational.
But how do most politicians and businesspeople view cronyism? So far as I’m aware, there have been no studies of politicians’ views on this matter. But Matthew Mitchell et al. have conducted an important study of businesspeoples’ beliefs about cronyism (A Culture of Favoritism: Corporate Privilege and Beliefs About Markets and Government). In a survey of 500 business leaders of big firms, 61% reported that their firm benefited from at least one form of favoritism, usually tax credits (p. 6). But 70% of all leaders also thought that the government should not favor specific firms or industries (37). This response was, however, much lower among those who thought that their firms were being favored (61.1%) than among those who thought that their firm was not being favored (83.8%) (pp. 36-38). Business leaders who are the recipients of government largess are more likely to believe that they are doing the right thing by their businesses and society by taking this largesse. It’s hard to say whether this favorable belief about cronyism is the effect of their cronyism, or its cause, or both. Fortunately, among business leaders and the broader public, 76% oppose favoritism. (“Fifty Years of Rent-Seeking: A Q&A with Matthew Mitchell,” in The Bridge, July 24, 2019.)
So, the task of changing the minds of those who think that favoritism is good for the economy and society, though hard, is not impossible. Another reason for hope is that at least two well-known left-wing scholars have recognized that regulation often helps big business at the expense of small business. The left-wing historian, Gabriel Kolko, writes about Progressives’ failure to see that the federal regulation of the economy that they were promoting was actually benefiting big business. (The Triumph of Conservatism, A Reinterpretation of American History, 1900-1916.) In 1973, the pro-government, activist lawyer Ralph Nader co-authored an article with Mark Green about the way government regulation of the economy ultimately ends up benefiting big firms at the expense of small ones, undermining competition and establishing monopolies (“Economic Regulation vs. Competition: Uncle Sam the Monopoly Man”). This led to a spate of (partial) deregulations of some major industries, including the airlines. Could this not happen again?
As for occupational licensing, which now covers about 33% of America workers, we can take hope from the fact that in the 1950s it covered only 5%. The efforts of the Institute for Justice have led to reforms in several states. Is it not possible that occupational licensing will continue shrinking?
There can never be a complete separation between the state and the economy, even if we have only a minimal state, because the state has to rely on private enterprise to fulfill its minimal functions: defending us from criminals and foreign enemies. It’s private enterprise that must build the roads, buildings, military vehicles, and weapons that the state needs to carry out its functions. Therefore the potential for cronyism will always be there, and so will the need for vigilance.