Government for Sale

What Is Crony Capitalism?

American government has never been entirely free from financial corruption. But after the Civil War, we had scandal after scandal. Why? Because government and business became “partners”; the line between the two blurred.

Sometimes this led to outright bribery. More often it led to the “soft” corruption of selling laws, tax breaks, rules, and decisions for campaign contributions, electioneering help, jobs, or other favors.

Government’s job is to guard and protect us. But who will protect us from the guardians themselves, once they become corrupt? There is no certain recourse against a corrupt government.

In Russia today, a holding company, Basic Element, run by the financial oligarch Oleg Deripaska, owes $650 million to Alfa Bank, led by fellow oligarch Mikhail Fridman. Fridman presses Deripaska for repayment. Deripaska speaks to the Russian president, Dimitry Medvedev. The president calls in Fridman and the loan is magically deferred.

Russia, having abandoned Communism, has embraced age-old principles of crony capitalism. The state does not own the private sector as it once did. But there are really no boundaries between private and public. When businessmen need political favors, they know whom to call. When politicians need money, they also know whom to call. The crony capitalists and politicians are clever; they keep most of it concealed behind closed doors.

The U.S. and other of the world’s most developed countries have not reached this point—yet. But day by day we are edging closer to the Russian model.

In 2008, before the rapid expansion of the federal government by the Bush and Obama administrations, government (both federal and state) represented about a third of the economy. The nonprofit sector represented roughly another 10%. This implied that a (bare) majority of the economy was comprised of private, for-profit concerns, the so-called private sector. But taking into account companies that are directly or indirectly controlled by government, perhaps as much as two-thirds of the economy is really in the government sphere.

The term Government Sponsored Enterprise (GSE) is generally used to describe private businesses that have been started by government and that continue to enjoy government support. The preeminent examples over the years have been the mortgage giants Fannie Mae and Freddie Mac.

It seems appropriate, however, to apply the term GSE more broadly to describe a large number of private firms, all of which either sell to government (defense), are highly regulated, subsidized, price supported, and cartelized by government (health care, drugs, housing, and banking and finance), or are dominated by government in a wide variety of ways (law, education, agriculture, autos, broadcasting, utilities, etc.).

The common theme that runs through all these broadly defined GSEs, apart from their dependence on government, is the large amounts of money they give to politicians of both parties and the large amount they spend on lobbying.

Campaign contributions are the main thing that politicians want from Wall Street firms and other GSEs. But there are other financial ties including funds from related foundations and jobs for friends or for the politicians themselves.

It is especially ironic that Wall Street is regarded by most people as the epicenter of market capitalism. It is, in reality, the epicenter of government-sponsored enterprise. Where Wall Street stops and Washington begins and vice versa is impossible to say. This situation was not caused, as many suppose, by the Crash of 2008. Rather the Crash of 2008 was caused by the longstanding Wall Street-Washington partnership.

 

What Can Be Done About Crony Capitalism?

Throughout history, people have dreamed about a good government that would guide the economy to make life better for the average person and especially the poor. In this dream, wise, unselfish, and far-sighted public servants make economic decisions for the greater good of all of us. In reality, public servants are rarely wise and far-sighted and never completely unselfish. They have their own interests, which in the case of politicians focus on the immediate need to get re-elected. The true public welfare, and especially the true long-term public welfare, is mostly ignored.

Public “servants” running the economy to serve their own interests are bad enough. But we get crony capitalism when the public servants reach out to ally themselves with rich people, corporations, labor unions, trial lawyers, or other powerful private interest groups. Often these crony capitalist alliances are formed under the fig leaf of government “regulating” the powerful private interests. But the reality is that government and special interests work out deals behind the regulatory smokescreen. In effect, they combine to run the economy for their mutual immediate advantage, not the long-term advantage of the general public which government is sworn to serve.

Many people think that the solution lies in making government regulation more honest or more effective. We respect this hope, but would not want to bet the future of the country on it. It is too much to expect that any government will ever be honest enough to avoid all the temptations of crony capitalism or wise enough to run the economy even if it could avoid the temptations. Indeed no one can be wise enough to run the economy. Only the preferences of millions of consumers expressed through competitive markets can successfully order and create our economic future.

Government does have a very important role to play. It is supposed to establish and enforce laws to ensure that markets are as honest and competitive as we can make them. No force, no fraud, no child labor, etc. In the long run, competition, along with the fear of failure and bankruptcy, is the most reliable regulator of our economic life.

Government needs to be a “cop,” not a player in markets (it is impossible to be both). It needs to refrain from making laws and regulations that actually interfere with and undermine honest competition, something which is happening constantly today. Subsidies to friends, government enforced monopolies, and price controls (especially controls on big prices such as currencies and interest rates) destabilize markets and lead to mass unemployment.

It is not surprising that powerful private economic interests hate open, honest, competitive markets and conspire with politicians and government regulators to protect what they have and prevent any change that might threaten them. Of course they offer any number of phony excuses about why this is good for us.

We can all talk endlessly about combating corruption and cleaning up the system. But this will never happen if we do not tackle the root of the problem— today’s out-of-control crony capitalism. So long as government “runs” the economy as it currently does, private economic interests will insinuate themselves into politics. Money and power will flow back and forth through ever more corrupted channels. Average citizens will always end up getting the short end of the stick, as they did during the infamous bailout of Wall Street and other financial centers following the Crash of 2008. Since 2008, crony capitalism has gotten worse, and so has the economy.

Capitalism has often been called a system run for the benefit business owners. This is usually contrasted to socialism, which is supposed to be run for the benefit of workers. But capitalism defined this way and socialism have much in common: they both just lead, in actuality, to crony capitalism. What we really need is a system run for the benefit of the average and especially the poor consumer.

Looking at all human history, it is remarkable how little economic progress we have made. The world’s economy has barely grown at all over the last several thousand years, and billions are still desperately poor. Throughout human history, also, economies have almost universally been run on crony capitalist lines—for the benefit of rulers and powerful allied special interests. If we are going to do anything about our present economic problems, and also give the billions of poor a chance at a better life, we will need to make a real break with crony capitalism.

The story of how crony capitalism has wrecked our economy, for millennia, but most recently running up to the Crash of 2008 and thereafter, is a sorry one. We will chronicle it on a day-to-day basis on this site, in the hope that the interconnections will be made clearer and the impetus for reform become stronger.

Hunter Lewis, August 2011

Note: This discussion of Crony Capitalism partly draws upon the “Government for Sale” chapter (14) of Lewis’s book Where Keynes Went Wrong (2009) and Lewis’s introduction to The Essence of Adam Smith’s Wealth of Nations (2011).