Crony Capitalism, Rent-Seeking, and the Growth of Government
by Wayne T. Brough, Ph.D.
cse.org
The collapse of energy giant Enron has unleashed a wave of moral outrage and a rash of investigations into potential abuse of the political system by a large multinational corporation. No doubt, cries of crony capitalism will fan the fires of campaign finance reform and greater financial oversight of the private sector. But the more important lesson is the dangers of a mixed economy, where the nexus between the private sector and the public sector becomes blurred.
Throughout the 20th century, the government came to play a larger and larger role in our economy. Through taxes, spending, and regulation, the government has become an integral part of business planning. As firms compete in the political arena rather than in the marketplace, economic growth is hampered and consumers and taxpayers bear the burden of inefficient policies designed to protect favored businesses. Lobbying has become a multi-billion dollar industry as companies jostle for protective legislation, so there should be little surprise when stories of "undue influence" bubble to the surface.
Selecting an economic system is an important decision that every society must make. From our inception, the United States has been a market-based economy that allows market forces to allocate resources. The Founders created a system of limited government that established the rules governing the marketplace. The role of the government was to protect private property rights, enforce contracts, and guard the nation against foreign threats. The common law was used to resolve disputes. Within this framework, individuals were free to interact as they saw fit, buying and exchanging property, entering contracts, and bringing goods and services to the marketplace.
With a dynamic private sector, the American economy prospered. Economics has demonstrated that, indeed, the market is the most efficient mechanism for allocating scarce resources. The alternative is government mandates and controls as typified by fascist, communist, and socialist models of resource allocation. Despite the success of the market, there has been continuing pressure to expand the role of government in the U.S. economy. Beginning with the Progressive movement in the latter half of the 19th century and the expansive policies of the New Deal in the 20th century, the government has come to play a greater role in decisions of resource allocation. As the government's role expanded, so too did the possibility for political mischief.
The shortcomings of government allocation of economic resources were most obvious in the centrally planned economies of the former communist nations. Lacking the vital information generated by prices in a market system, Soviet planners failed to allocate resources effectively. Without prices to clear the markets, Soviet planners relied on faulty data or political patronage that led to a chronic under supply of consumer goods and services. Ultimately, the system collapsed under its own weight in the 1980s.
Proponents of big government hold up the "mixed economy" as an alternative to the market economy that avoids the pitfalls of a centrally planned economy. The mixed economy purportedly allocates resources efficiently while also allowing the government to address concerns other than efficiency. While "mixed economy" is an apt description of the post World War II welfare states of the West, Japan's booming economy in the 1980s was often viewed as the epitome of the mixed economy. Industrial planning was a key component of Japan's mixed economy, with the government actively directing the flow of capital to specific sectors and industries. The public-private partnership of "Japan, Inc." was said to demonstrate the importance of an active government role in making business decisions.
Japan's success in the 1980s fostered a new interest in alternatives to purely market-driven economic growth. With the rise of the Asian Tigers and the expansionary boom in Southeast Asia, many professed that managed economies provided a feasible alternative, particularly in Asia where cultural differences were said to favor patron-client relationships that would make a public-private partnership successful for managing their economies. Yet today, such mixed economies are in tatters. Japan is facing its most serious economic crisis in the post-war era, and the economies of Southeast Asia are still reeling from the economic collapse of 1997. Crony capitalism and corruption are commonly viewed as the key culprits, with capital flows dictated not by economics, but by political favoritism.
While it is true that the U.S. economy may be described as a mixed economy, this is a sign of encroaching government that should not be viewed as fostering economic growth. As with Japan and the Asian economic crisis, the increasing role of government suggests a larger role for political interests that detract from economic growth. Crony capitalism and special interest politics become just as important as competition in the market place.
In fact, a more fitting description of the increasing role of government may be the rise of the "rent-seeking" society. In economics, the term "rent" refers to windfall profits. In a competitive market, these profits cannot be sustained because the profit attracts competition, which brings the prices down to competitive levels. The term "rent-seeking" refers to firms or industries seeking government rules or regulations that provide windfall profits. These profits are permanent and not eliminated by competition because legislation or regulation prohibits competitors from entering the market.
In other words, rather than seeking profits in the marketplace, rent-seeking firms pursue profits through the political process. Profit-seeking in the marketplace is efficient and fosters economic growth because increased profits are generated by serving consumers better or finding more efficient means of production. However, rent-seeking tends to be inefficient and harmful to economic growth because resources are diverted from the production of goods and services in order to protect inefficient firms and industries.
As firms seek favorable legislation or regulation, this invites a response from competitors, who may respond with lobbying efforts of their own, simply as a defensive mechanism. And once a firm obtains rents through the political process, it will expend even more resources to defend and maintain those rents. In turn, this expands the government's role in important economic decisions as Congress and the regulatory agencies issue new mandates on economic activity that limit market-based decisions. The rent-seeking society and crony capitalism go hand in hand. In fact, crony capitalism is a misnomer. It is not capitalism at all; capitalism is a system of market-based economic decision-making, while crony capitalism relies on government intervention and favoritism.
The greater the role of government in the economy, the greater the potential for harmful rent-seeking. In fact, a study by the Joint Economic Committee found that a 1 percent increase in government spending as a share of our nation's economic output generated a ½ percent decrease in economic growth. This result is consistent with the notion that as government spending and regulation play a larger role in our economy, rent seeking increases and the ability of the market to allocate resources efficiently is diminished.
And the government's role in our economy has grown significantly over the last century. In 1929, government spending accounted for only 7 percent of the GDP. By 2000, government spending was over 28 percent of GDP. That is roughly $2.8 trillion in spending by the federal government, and this excludes the cost of regulations. The Office of Management and Budget states that there is $692 billion in discretionary spending in the 2002 budget. With politicians seeking re-election and special interests seeking favors, this is bound to prompt political expediency over market efficiency.
Beyond the government's tax and spending policies, government regulations also play a significant role in our economy. Overall, the economy faces a regulatory burden of more than $800 billion annually. In the year 2000, more than 4,300 rules were introduced by the federal government alone. Critical sectors of our economy, including telecommunications and the deployment of broadband systems, insurance and financial services, and energy remain mired in regulation. It is no wonder that many of the top political contributions come from sectors such as energy and telecommunications.
When the government comes to play such a significant role in economic decision-making, rent seeking increases. No longer can firms compete simply by providing a better product or service, they must now be constantly engaged in the political process. Microsoft learned this lesson the hard way, as its rivals pressured Washington to bring a landmark case against the company, despite any evidence of consumer harm. As the private sector devotes more resources to the political process, resources are spent not on producing goods and services, but on lobbying.
While some may call for campaign finance reform, this will do little to address the problem (even if it passes constitutional muster). Real campaign finance reform means reducing the size and scope of government behavior. If there are true concerns about undue influence, every effort should be made to limit the government's role in the economy and therefore the need for businesses to pursue congressional and regulatory interests. But with a government that spends almost a third of our nation's output and issues regulations that affect virtually all businesses in the nation, it is impossible to avoid the ensuing rent seeking.
The Enron story rightly has raised a number of important questions. But to focus on crony capitalism or political scandal without addressing the larger question of the growing nexus between business and government is to ignore a fundamental question. Namely, what is the proper scope of government in our economy? Our nation was founded on the premises of limited government and a thriving private economy, which allowed our nation to flourish. However, government has been expanding its role and business can no longer ignore the realities of politics. Enron provides an important wake-up call, and offers the administration an opportunity to renew the division between governments and markets, with governments establishing the framework for market activities, but retreating from active participation in private sector decisions. |
