Category Archives: Crony Capitalism

Government-Granted Privilege is not Capitalism

Here is a familiar cycle:

Step 1: Congress imposes a tax, often a steep one.

Step 2: Convinced that it is well-suited to pick winners and losers, Congress then allows certain people or firms to get out of some or all of the tax by engaging in certain activity: having a child, taking out a mortgage, caulking windows, buying certain capital equipment, manufacturing things rather than selling valuable services, etc.

Step 3: Firms and individual do what Congress intended and avail themselves of these privileges, lowering their tax bill.

Step 4: Members of Congress pronounce themselves shocked—absolutely shocked—that some firms and individuals unpatriotically pay little or no tax.

A few years ago, the story was General Electric. Now it is Google. Google Chairman Eric Schmidt defended the company’s practices, saying:

We pay lots of taxes; we pay them in the legally prescribed ways…I am very proud of the structure that we set up. We did it based on the incentives that the governments offered us to operate.

So far so good. He didn’t make the rules that privilege his firm, but he will avail himself of these privileges when offered. I can sympathize. I oppose the mortgage interest deduction but still take it every April. Schmidt’s next statement, however, is about as far from the mark as one can get:

It’s called capitalism….We are proudly capitalistic. I’m not confused about this.

A quick lesson for Mr. Schmidt: genuine capitalism is about competing on a level playing field for customer dollars. If you offer a superior product or service, customers will reward you by voluntarily parting with their money in exchange for what you offer.

Competing on a manifestly un-level playing field is not capitalism. It goes by many names: cronyism, crony-capitalism, corporatism, state-capitalism, privilege, etc. But whatever you call, please don’t call it capitalism.

 

The Study of American Capitalism

(Note to readers: Three talks in three states over the last week have made me a terrible blogger. Thankfully, Eileen and Emily have stepped up where I have stepped down.)

Mercatus has now organized its work around government-granted privilege and crony capitalism under a new project called the Study of American Capitalism. We are thrilled that Celia Sandel has joined the Mercatus team to manage the project. If you are a scholar working or thinking about working in this field, please reach out to Celia. We’d love to hear from you.

Speaking of which, we’ve already released a number of excellent papers on the topic. And now, in no particular order:

In Crony Capitalism: By-Product of Big Government, Professor Randal Holcombe of Florida State University explores the links between government power and cronyism, writing:

The more government is involved in an economy, the more the profitability of business will depend on government policy. Even those entrepreneurs who would prefer to avoid cronyism are pushed into it, because they must become politically active to maintain their profitability. When the government looms large in economic affairs, businesses push for government policies that can help them, and try to avoid suffering harm as a result of government policies that can work against them. If one’s competitors are engaging in cronyism, avoiding cronyism means that one’s competitors will gain government-bestowed advantages.

In Government Cronyism and the Erosion of Public Trust, Professor John Garen of the University of Kentucky examines the relationship between cronyism and eroding trust in government. He writes:

Survey data show a large decline in trust in government, much of which has occurred while government grew rapidly. Evidence indicates that government growth has been associated with rent-seeking and cronyism, leading to a withdrawal of trust. Thus, cronyism—bad government— can undermine even the appropriate functions of government.

Professors Daniel Smith and Daniel Sutter of Troy University gauge public perceptions of the problem in Gauging the Perception of Cronyism in the US:

Cronyism can have real and significant costs, yet it is challenging to measure objectively. In fact, just the perception of cronyism can inhibit business formation, distort the allocation of entrepreneurial talent, and undermine support for free market capitalism. Refined measures of perceptions of cronyism among both business leaders and the public could help advance our understanding of cronyism and its effects on our economic system.

Last, but by no means least, my graduate-school colleague Professor Jeremy Horpedahl of Buena Vista University has teamed up with my current student, Brandon Pizzola, to explore the privileges that lurk in our tax code in A Trillion Little Subsidies:

Total tax expenditures in the United States are currently around $1 trillion, with over 80 percent accruing to individuals and the remainder to corporations. We review each of the ten largest tax expenditures for individuals and corporations, focusing on the following distortions of economic activity: spending on goods and services, capital allocation, the distribution of income, and lobbying and rent-seeking. The benefits of tax expenditures accrue disproportionately to higher-income earners, since they are more likely to itemize deductions and can afford to hire accountants to minimize their tax burden. Eliminating tax expenditures would increase economic growth and allow for lower tax rates, further increasing growth.

(Many) more to come!

Nanny state could save Madrid from EuroVegas

Las Vegas real estate developer Sheldon Adelson selected Madrid as the site of his next proposed casino project, EuroVegas, last month. The project is estimated to create 250,000 jobs in a country with 25% unemployment. On the one hand, this project may look like a good bet for the city, bringing both short term construction jobs and hopefully creating a long-term tourist destination.

However, EuroVegas will not be financed completely with private investment. Instead, Adelson wants to pay only 35% of the projects construction costs, asking the city to finance the rest. Additionally, he requires that the project receive property and business (IAE) tax breaks. Since most of the investment will be taxpayer funded, the risk is borne largely by the public and the project requires Madrid taxpayers to take on even greater debt. The tax-exempt project will not contribute to the tax base for public services. Adelson selected Madrid as the EuroVegas site after receiving better breaks there than Barcelona policymakers offered.

Carlos Ruiz, a retired engineer, heads the group EuroVegas No. He sums up the feelings of some who feel that the project would benefit Adelson at the expense of Spanish taxpayers who already have a high debt burden:

“Citizens from the whole of Europe are lending money to Spanish banks because they are in a bad situation — hoping that someday these banks will start to give credit to small enterprises, to families, to people,” Ruiz says. “But this money is going to go to Mr. Adelson, who is one of the richest men in the world. This is quite unfair.”

Madrid officials seem poised to offer Adelson all of the concessions he seeks, including subsidies, tax breaks, and exemptions to labor laws, except for one. The sticking point in the deal may be that the project requires an exception to Spain’s nationwide ban on smoking in bars and restaurants to go forward. Prime Minister Mariano Rajoy said that lifting the smoking ban for EuroVegas would give the development unfair political privilege over all of the country’s other establishments where smoking is not permitted. He said he thought that making an exception to the ban for EuroVegas would be unconstitutional.

Whether or not EuroVegas will go forward in Madrid remains to be seen. Either way, Rajoy’s approach to a level playing field is worth noting here. As Matthew Mitchell explains in his paper “The Pathology of Privilege,” creating special advantages for projects like EuroVegas tends to benefit well-connected people at the expense of the general interest and limits economic growth as resources are directed according to political favor rather than by the market.

A Congressional Cookie Jar with Oak Tree Roots: The Economic Development Administration

David Bier of the Competitive Enterprise Institute makes the case in a recent paper for the abolition of the Economic Development Administration. The history of the EDA is tied into the programs of the Great Society which spawned many fiscal and programmatic connections between federal, state and local agencies with the ostensible aim of spurring local economic improvement (e.g.The Community Development Block Grant). Fifty years on and these programs haven’t lived up to the grandiose mission statements of their architects. The EDA is part of the framework through which stimulus dollars flowed and Bier’s article underscores the key objections to the application of federal dollars to local economic development.

Interestingly, the EDA has been the subject of several academic studies over the years. The classic public administration book, Implementation, by Jeffrey L. Pressman and Aaron Wildavsky undertook an early case study of the EDA in Oakland, California with its inaugural goal of hiring long-term unemployed minorities. They conclude that while advocates had “great expectations” the program produced meager results with impulsive project choices and cost overruns. The cause, the authors postulated, was a delay in implementation and cumbersome bureaucracy.

Pressman and Wildavsky seem to have documented a familiar tale of public choice theory: the malincentives present in bureaucracies and tendency toward inefficiency. Their classic book on programmatic breakdown has touched off another debate recently in the literature centered around the question, “What ever happened to the study of policy implementation?” An intellectual dead-end was encountered according to deLeon and deLeon which can be revitalized by considering policy implementation not from the top-down but from the ground-up.

Pressman and Wildavsky sliced into their analysis in keeping with the dominant theories of the time. They view the EDA in a top-down fashion – as a single federal programmatic entity acting on subordinate levels of state and local government. Since their 1973 classic, advances made by Vincent and Elinor Ostrom and others point to the fruitfulness of thinking in terms of polycentric rather than monocentric orders. That is, to consider policies in horizontal instead of vertical terms. Map out the multiple decision nodes that connect government, marketplace and community.

B. Guy Peters in his article, Implementation Structures as Institutions, notes that in the last decade, the public administration literature now strives to make just such connections in understanding how policies are implemented. It’s an important advance which allows for a more complex and nuanced picture of the effects of programs. Such analysis may help answer one perennial question: how is it that small-budget, experimental programs inspired by mid-century economic theories grow deep roots and resist any kind of reform, alteration or pruning for generations?

When we consider federal spending programs and trace their effects we often see the fleeting connections and feel a sense of unease. A former EDA administrator calls the program, “A Congressional Cookie Jar.” From his vantage point the program is an expense account for politicians to sprinkle federal dollars on their districts. But as EDA grants are scattered among municipal governments, what else happens along the way? How do constituencies coalesce? Who benefits and who loses? Where do the dollars go and how are connections forged between private, non-profit and public sector actors. Metaphorically speaking, how did a single-shot grant in the mid-1960s become an oak forest?

One Man’s Privilege is Another’s Punishment

When governments bestow privileges on particular firms, they also impose costs on others. A recent CNN report brings this to light (HT, Rob Raffety).

It tells the story of Bill Keith, an entrepreneur who started a small business out of his garage. He installs solar-powered attic fans that pump away hot air and lower cooling bills. The Obama campaign heard about him and sent someone out to meet (vet) him. Soon the campaign, and then the Administration, was featuring Mr. Keith in speeches and other materials. His story was perfect politics: small businessman meets green energy meets financial success.

Mr. Keith’s business soared, peaking at $5 million in revenue in 2009. But more recently he’s run into trouble:

Today, Keith’s solar star appears to be on a collision course with another Obama policy that may put him out of business. The irony is not lost on Keith: A man whose profile and company soared because of the administration’s energy policy [MM: it isn’t clear from the story what policy he actually benefited from, other than the loads of free advertising] is now falling apart because of a new Obama anti-dumping policy involving China.

While 95 percent of Keith’s fans are American-made, he has yet to find a U.S. company that can make the small customized solar panels that make his fans run.

So he has had to turn to—gasp—Chinese suppliers. And that has made him a target of the Administration’s so-called “anti-dumping” policy. Unless he can prove that the panels he buys are not Chinese-made, he faces tariffs as high as 250% (!). This is an effective rate of $270,000.

In response to CNN inquiries a White House spokesperson responded:

[T]hat the tariff “highlights the degree to which solar panel manufacturers have faced unfair competition from countries like China” and the president’s move to impose a tax on Chinese-made goods is a way to establish “a level playing field with China for American businesses and workers.”

There is a reason that economists are nearly unanimous in supporting free trade. Though tariffs such as those on imported solar panels are a privilege for domestic panel manufacturers, they are a burden for domestic consumers such as Mr. Keith. To make matters worse, economic theory and evidence long ago established the point that the costs borne by consumers outweigh the benefits bestowed on producers.

In this case, there is another cost: debasement of the English language. Notice the words used by the spokesperson. In order to establish a “level playing field” we need to tilt the playing field in favor of domestic producers at the expense of foreign producers and domestic consumers. So an uneven playing field is an even playing? Newspeak, much?

When Politicians Encourage Rent Seeking

In the second appendix to the Pathology of Privilege, I list a number of questions for further research. One question is:

Do governments pass out privileges because firms have developed ties with political decision makers? Or do firms get close with political decision makers because they are passing out favors?

My colleague Adam Thierer recently uncovered a remarkable example of politicians encouraging firms to get close with decision makers so that they might hand out favors:

I was flipping through the latest copy of “The RCA Voice” which is the quarterly newsletter of what used to be called the Rural Cellular Association, but now just goes by RCA. RCA represents rural wireless carriers who, among other things, would like increased government subsidies for–you guessed it–rural wireless services. Their latest newsletter includes an interview with Rep. Don Young (R-AK) who was applauded by RCA for launching the Congressional Universal Service Fund Caucus, whose members basically want to steer even more money into the USF system (and their congressional districts). Here’s the relevant part of the Q&A with Rep. Young:

RCA VOICE: “How important is it for carriers serving rural areas to be engaged with their members of Congress on USF issues?”

REP. DON YOUNG (R-AK): “The more carriers engage with both their Representatives and Senators, the better. While the early bird may get the worm, the bird that doesn’t even try definitely won’t get any worms. The same applies to Congress.”

In Adam’s words,you gotta admire chutzpah like that! It pretty much perfectly sums up why universal service has always been a textbook case study of public choice dynamics in action.”

 

Want Money Out of Politics? Eliminate Government Discrimination

In my work on government-granted privilege, I have repeatedly emphasized the surprising degree of harmony between left and right on this issue. Both abhor the tawdry nexus between corporate power, money, and politics.

(As evidence that I am not the only one who sees such agreement, note that Occupy.com recently reprinted an article highlighting the Mercatus project).

In an article from Friday, progressive blogger Ezra Klein seems to bolster this point:

According to Harvard law professor Lawrence Lessig, only 0.26 percent of Americans give more than $200 to congressional campaigns. Only 0.05 percent give the maximum amount to any congressional candidate. Only 0.01 percent — 1 percent of 1 percent — give more than $10,000 in an election cycle. And in the current presidential election, 0.000063 percent of Americans — fewer than 200 of the country’s 310 million residents — have contributed 80 percent of all super-PAC donations.

“This, senators, is corruption,” Lessig said Tuesday, in testimony before the Judiciary Committee. “Not ‘corruption’ in the criminal sense. I am not talking about bribery or quid pro quo influence peddling. It is instead ‘corruption’ in a sense that our Framers would certainly and easily have recognized: They architected a government that in this branch at least was to be, as Federalist 52 puts it, ‘dependent upon the People alone.’ You have evolved a government that is not dependent upon the People alone, but that is also dependent upon the Funders.”

There is much in here with which I agree. Campaign spending begets access. Access begets privilege. And privilege, in my view, “misdirects resources, impedes genuine economic progress, breeds corruption, and undermines the legitimacy of both the government and the private sector.”

The same article, however, also highlights the ways in which progressives and libertarians disagree about money, politics, and power. Klein quotes and quickly dismisses Cato scholar Ilya Shapiro. In his own testimony, Shapiro argues:

To the extent that ‘money in politics’ is a problem, the solution isn’t to try to reduce the money — that’s a utopian goal — but to reduce the scope of political activity the money tries to influence. Shrink the size of government and its intrusions in people’s lives and you’ll shrink the amount people will spend trying to get their piece of the pie or, more likely, trying to avert ruinous public policies.

This, Klein argues, is impractical. Moreover, he says, “between the dismantling of the social safety net and the destruction of our military might, the cure might be worse than the disease.” Instead, Klein’s preferred solution is campaign finance reform, perhaps necessitating a Constitutional Amendment to get around First Amendment concerns.

I’ll admit I favor Shapiro’s solution. If we shrink the size—and more importantly, the scope—of the government, the wealthy and well-connected will have nothing to gain from playing politics. I also happen to think that Klein’s solution—controlling political speech—is, in fact, “worse than the disease.” (I think Madison would agree…he even used similar language). Moreover, I think that there are plenty of programs to shrink or eliminate before we get to cuts that eviscerate the safety net or threaten our security. To pretend otherwise is to “shoot the cocker spaniel.”

But in the interest of finding common ground with my progressive friends, let me suggest a modest compromise: the abolition of favoritism in government policy. In an interview with James Buchanan, F.A. Hayek once remarked:

[The First Amendment] ought to read, ‘Congress shall make no law authorizing government to take any discriminatory measures of coercion.’ I think that would make all the other rights unnecessary.

This quotation appears in the beginning of an excellent—but often overlooked—book by Buchanan and Roger Congleton called Politics by Principle, Not Interest: Toward Nondiscriminatory Democracy.

Buchanan and Congleton brilliantly trace the political and economic consequences of forgoing favoritism. What happens when government adheres to a sort of “generality” principle by which all policies are required to apply to all equally? What if there are no carve-outs in the tax code? No special favors in the appropriation process? Notice that this need not be the sort of libertarian paradise that Shapiro and I favor. Government might still spend a lot of money and it might still tax a great deal. But it would be constrained by the generality principle to tax and spend in a nondiscriminatory way (Buchanan and Congleton make an allowance for a safety net by proposing “a flat rate of tax on all income combined with a set of equal-per-head demogrants,” p. 161).

Generality would require both sides to give up their own pet projects which favor particular segments of society. No more “targeted investments” in particular green technologies. No more tax credits for people who have kids. No more subsidies for farmers. No more favors for manufacturing. No more bailouts of some firms and not others. Under such a constraint, a majority of Congress could elect to subsidize industry A, but it would also have to subsidize industries B-Z.

The proposal has an intuitive moral appeal. Government, after all, is constituted to promote the general welfare of the entire population, not the specific welfare of certain segments of society. But as Buchanan and Congleton show, it also has economic appeal. For under a generality rule, “no participant has an incentive to invest resources in efforts to secure differential or discriminatory advantage at the expense of others in the collective enterprise.” (p. 44). And that can make the difference between a society that prospers and one that stagnates.

We all—right, left, libertarian, and progressive—seem to agree that something is wrong when wealthy individuals donate to politicians and politicians hand out privileges to these donors. Klein and Lessig think the answer is to regulate donations. Shapiro and I think the answer is to limit the scope of government.

We can continue to talk past one another while the nation slips deeper and deeper into the grips of the pathology of privilege. Or, we can roll up our sleeves and think of alternative solution that might be acceptable to both the left and the right. How about the abolition of favoritism in government policy?

Milton Friedman Would Have Been 100 Today

There have already been a lot of great paeans. I’d recommend this article by Thomas Sowell or this blog post by Bryan Caplan or this collection of remembrances by David Henderson. Friedman is justifiably remembered as an excellent economist whose timely and careful research on consumer behavior, money, and economic history literally upended conventional economic wisdom. But he is also remembered as an eloquent and impassioned public voice on behalf of individual freedom.

In that spirit, I think the best tribute is to let him speak for himself. Courtesy of Don Boudreaux, here is Friedman on freedom, government and conformity:

What the market does is to reduce greatly the range of issues that must be decided through political means, and thereby to minimize the extent to which government need participate directly in the game. The characteristic feature of action through political channels is that it tends to require or enforce substantial conformity. The great advantage of the market, on the other hand, is that it permits wide diversity. It is, in political terms, a system of proportional representation. Each man can vote, as it were, for the color of tie he wants and get it; he does not have to see what color-the majority wants and then, if he is in the minority, submit.

It is this feature of the market that we refer to when we say that the market provides economic freedom. But this characteristic also has implications that go far beyond the narrowly economic. Political freedom means the absence of coercion of a man by his fellow men. The fundamental threat to freedom is power to coerce, be it in the hands of a monarch, a dictator, an oligarchy, or a momentary majority. The preservation of freedom requires the elimination of such concentration of power to the fullest possible extent and the dispersal and distribution of whatever power cannot be eliminated – a system of checks and balances. By removing the organization of economic activity from the control of political authority, the market eliminates this source of coercive power. It enables economic strength to be a check to political power rather than a reinforcement.

And courtesy of Professor Miles Kimball, here is a collection of Friedman videos. In the spirit of Mercatus’s latest initiative on cronyism, here is Friedman on the government and the power of the industrialists:

 

(HT, Steven Mitchell)