There was once a time when politicians bought "treats" for electors. In his biography of William Wilberforce (2008), the former British Foreign Secretary William Hague set out the scale of the hospitality that nineteenth century parliamentarians offered to their prospective electors. On one occasion the Grosvenor family of Chester spent £8,500 over the course of an election to buy the support of locals. That £8,500 bought 1,187 barrels of ale, 3,756 gallons of rum and brandy and over 27,000 bottles of wine. I can only assume the alcohol wasn't all consumed in one day or the electors would not have found their way to the voting booths – let alone remember where to place their cross.
It is the other way round of course today. Some contemporary American politicians spend four hours per day on “call time” – raising money. As it gets closer to election time Senators can spend two-thirds of their time seeking donations. British politics is not entirely immune from the influence of money either. Just look at appointments to the House of Lords. An exhaustive survey carried out by academics at Oxford University found a statistically extraordinary link between donating to a political party and becoming a member of the Upper House. Looking at the likelihood of donating to a political party and winning a peerage they likened the probability to entering the National Lottery and winning the jackpot five times in a row. Perhaps surprisingly, the Tories turned out to be the cheapest. The average entry fee for a Conservative donor was £220,000; £333,000 for a Liberal Democrat; and £464,000 for a Labour wannabe.
And what do donors get in return for their money? The billionaire Donald Trump has said a few controversial things on the campaign trail in the summer of 2015 but in one moment of extreme candour he did what few donors to political parties ever do – he admitted that he gave in order to receive:
“I will tell you that our system is broken. I gave to many people, before this, before two months ago, I was a businessman. I give to everybody. When they call, I give. And do you know what? When I need something from them two years later, three years later, I call them, they are there for me. I'll tell you what, with Hillary Clinton, I said be at my wedding and she came to my wedding. You know why? She didn't have a choice because I gave.”
Most donors don’t give in order to get political heavyweights to turn up to their latest wedding but what do they give for?
GIVING IN ORDER TO RECEIVE
Most, in my limited experience of British Conservative politics, genuinely give because they believe in a political cause. They give because they are Eurosceptics and the Tory Party is Eurosceptic. They give because they are friends of Israel and the Tories are (generally) friends of Israel. The money follows the belief rather than the other way round. In particular, it’s rare in most advanced western nations for there to be a direct link between donations and the awarding of a contract. Most contracting of government services is carried out by independently audited public servants and is hard to corrupt. Money does buy other kinds of special privileges, however. For example:
· Complex regulations: Contrary to popular belief many big businesses quite like and seek regulation. If you are a major Wall Street bank you can afford large compliance departments and top tier lawyers to both design and then navigate complex regulatory systems. Regulation can actually be of huge public benefit to your firm if it leads to the public thinking you are safe for them to contract with. Because a bank, for example, is overseen by a government body, investors can believe that their money is safe – or at least investors had that assumption before the 2008 crash. An extensive regulatory system is much harder for a small, upstart financial institution to cope with. The unit costs of regulation fall much more heavily upon them. All of this was set out by George Stigler in his 1971 arguments about “regulatory capture”. Government departments or agencies that are set up to promote the public good become captured by the entities that they are supposedly masters of. There is also the generally depressing economic impact of regulation. Antony Davies of Mercatus Research reports:
“Over the period 1997 through 2010, the least regulated industries experienced 63 percent growth in output per person, 64 percent growth in output per hour, and a 4 percent decline in unit labor costs. Over the same period, the most regulated industries experienced 33 percent growth in output per person, 34 per cent growth in output per hour, and a 20 percent increase in unit labor costs.”
· Licences to work: This is another version of the same problem. Anyone wanting to enter a particular trade or profession needs to cross certain hurdles. Sometimes those hurdles are proportionate and are in the public interest. They guarantee that the public is served by properly trained people. Far from always, however. The US-based Institute for Justice investigates the occupational licensing system and fights the hurdles to accreditation that simply amount to restrictionist barriers to entry. The attempts to regulate the braiding of hair being a depressing case in point. In these circumstances, accreditation schemes become constructed with the connivance of well-connected businesses who want to frustrate possible competitors.
· Picking winners: While direct lobbying for a subsidy for an individual firm is unusual in advanced nations it is not so unusual for whole sectors. In recent years the renewables energy sector has won considerable subsidy from government for investing in technologies which the likes of Bill Gates believes are immature and are consequently a waste of public money.
· Excessive forms of patent protection: The composers of the Happy Birthday song Mildred and Patty Hill – died long ago. Mildred Hill in 1916. Patty Hill in 1946. The owners of the music – Warner Chappell – have nonetheless benefited from generous copyright laws that allow owners of copyrighted material to claim royalties from it for 70 to 95 years (see Ross Clark in The Times (£)). When copyright or patent laws are too protective of invention for too long it stops encouraging innovation and R&D – instead it encourages companies owning patented material to wring more profit out of existing inventions. The need to fix the patents system was the subject of a recent Economist cover editorial. While inventors deserve recognition and reward for their efforts there is a strong case for shorter lengths of copyright protection – especially in industries where the development period is shorter. “Protection for 20 years might make sense in the pharmaceutical industry,” thundered The Economist, “because to test a drug and bring it to market can take more than a decade.” It continued: “But in industries like information technology, the time from brain wave to production line, or line of code, is much shorter. When patents lag behind the pace of innovation, firms end up with monopolies on the building-blocks of an industry.” From the opposite ends of the spectrum the libertarian Cato Institute and Joseph E Stiglitz agree. At the same time there needs to be more protection of patent holders from frivolous legal trolling. Since the 1980s patent trolling in the US has increased by 600% with – according to research quoted in the Harvard Business Review – a very damaging impact on R&D spending. Mike Montgomery at Forbes worries that “innovators cannot build companies in the face of meritless patent lawsuits” – especially if they come from protectionist governments like France. Litigation could be reduced if patents weren’t so vague and broad but, unfortunately, a recent bipartisan effort by Senators Chuck Schumer and John Cornyn to shift the burden of proof to patent litigators and from patent holders is stalling in America’s gridlocked Congress.
· Export credit regimes: The argument for giving export guarantees to big exporting companies is that other countries’ industries will win export contracts if they aren’t offered by their own country’s government. The problem is that they can socialise risk and privatise reward if firms aren’t charged adequate fees for what is essentially a heavily subsidised insurance policy. When some leading American Republicans decided that they were no longer willing to fund the US Export-Import Bank one of its major beneficiaries – Boeing – cut off the donations it made to those politicians. The transparency of their actions were Trump-like. You can argue that ExIm guarantees are necessary if the likes of Boeing can’t buy similar guarantees commercially but it is also clear what and who is being bought.
· Too Big To Fail financial policies: These are examined separately in chapter ten.
THE DESERVING RICH AND THE UNDESERVING RICH
Speaking at the 2015 Conservative Party Conference Michael Gove, the UK Justice Secretary, made a distinction between the deserving rich and the undeserving rich. The deserving rich, he said, work hard, are creative and add value to society. His target, in contrast, was an undeserving rich who play the markets, rig rules and sit on each other’s remuneration committees. He called for today’s Conservatives to tackle the undeserving rich with the same determination as the monopoly-busting Teddy Roosevelt demonstrated when he tackled the anti-competitive practices of his time. Mr Gove specifically singled out people at the World Economic Forum in Davos who lecture the rest of the world on the importance of competitive markets but still get handsome reward packages if and when they fail.
Iain Duncan Smith, the Work and Pensions Secretary, was quick to agree with the Lord Chancellor’s analysis. No free market Conservative should begrudge people who have risked everything and built a business and created jobs from being handsomely rewarded. But, IDS continued, in recent years capitalism became associated with a financial system that was quick to punish small business people or private households who fell into financial distress. Someone who didn’t pay back their loans on time was blacklisted on credit files for many years, for example. But when those same banks and financial institutions got into trouble themselves they were bailed out by government and a different set of rules seemed to apply. If the rich can’t get poorer because the system protects them, the system loses legitimacy.
Now, is a good time to return to the very beginning of chapter one where we noted Andrew Lilico’s reaction to the huge government bailouts of Wall Street and the City of London. Let’s quote some more of his wisdom:
“Capitalism is all about responsibility – if your ideas don't work, you don't make money; if you fund the wrong projects, you lose your money. Capitalism is a system of consequences – failure (through incompetence, laxity or bad luck) has the consequence of loss. Consequences for failure is a central part of what Capitalism is about. If failure is forbidden – if the state intervenes to bail out banks, to bail out their bondholders and depositors – then we don't have Capitalism.”
And here we get to the heart of why crony capitalism doesn’t just raise moral questions but also raises concerns about the dynamism of advanced economies. The OECD believes that the “diffusion machine” – the process by which good ideas are translated by businesses into product - is breaking down. Some say that innovation in general is slowing down (notably Robert Gordon) but the OECD has a different explanation. It blames government policies – often designed to protect the environment or the status of a profession – but which add up to favouring incumbents across a whole range of areas.
The problem is particularly great in Spain and Italy:
“In countries where this pattern is particularly prevalent – Italy and Spain – the OECD said better used of workers skills could boost productivity by as much as 10%. The OECD’s analysis has echoes of the “zombie firm” hypothesis used by some economists to explain weak productivity growth in the immediate aftermath of the financial crisis. In that analysis, state-supported banks were discouraged from calling time on problem loans, thus allowing businesses that otherwise would have failed to survive. But the OECD’s analysis suggests there is a more general problem with the way markets are working.”
James Pethokoukis, writing for the National Review, fears that excessively close relations between government and corporates is undermining the “creative destruction” that Joseph Schumpeter correctly identified as essential to the forward momentum of capitalist societies:
“New companies made up roughly half of all American businesses in 1982 versus just a third today. These findings suggest big problems at the heart of America’s version of entrepreneurial capitalism. Start-ups generate the “disruptive innovation” that creates new goods, services, and jobs. And they force established businesses to try to match them. Without competition from new companies, old ones will pursue only the sort of “efficiency innovation” that makes production cheaper, often by replacing people with machines. The U.S. still generates lots of innovation overall, but maybe too much is of the job-killing sort rather than job-creating kind that marks a dynamic economy.”
On the American Enterprise Institute’s website he published graphs that underlined his thesis about declining entrepreneurialism:
CRONY CAPITALISM HAS NEVER BEEN EASIER TO ENGINEER...
“Throw Them All Out: How Politicians and Their Friends Get Rich off Insider Stock Tips, Land Deals, and Cronyism That Would Send the Rest of Us to Prison” is a book by Peter Schweizer - the William J. Casey Fellow at the Hoover Institution, Stanford University. The title is certainly “WYSIWYG” – What You See Is What You Get. Interviewed about his book by the Acton Institute he explained why he thought crony capitalism was a bigger problem than ever before – bigger than ever before because of the size of government and the complexity of contemporary legislation:
“Two hundred years ago, they might try to get a railroad going through their land and they might buy up the land beforehand. That sort of thing goes on, but in an area where literally the federal government is handing out tens of billions of dollars in loans and grants, the amount of money that can be made and the opportunities are just so much greater than they've ever been historically, and that relates to the size of the budget and the amount of money that's being passed around. I think the second thing is it's also more widespread because it's harder to detect. Things in Washington now are so much more complex and difficult to follow that it's easier to camouflage what you're doing. If you've got, say, a healthcare bill that is 2,000 pages long, it's very easy to have some small clause in there that's going to have some huge benefit to a certain industry or a certain company. And if you're on the inside and know that and can trade stock based on that information, that presents a huge advantage that didn't exist before. Likewise, I use the example of former Speaker of the House Dennis Hastert. If you can insert an earmark into the highway bill, it's a lot easier to cover your tracks than it would have been 100 years ago when the size of bills and the role of government was much smaller. The amount of money and the complexity of government both make it much more opportunistic for people to engage in this kind of stuff.”
...AND IT SHOULD REALLY BE CALLED POLITICISED CAPITALISM
The Economist has stated that we need “a revolution to save capitalism from the capitalists” but it takes two to tango. The capitalists are only half of the problem. Laziness, ideological failure or pure greed has led politicians to form socially harmful relationships with powerful business lobbies. We probably shouldn’t call it crony capitalism but politicised capitalism. We need to tackle the idea that people in government are more angelic or wiser than people in free enterprise. Reform might need to begin within the economics profession.
Economic textbooks are routinely full of the study of “market failure” and market failure, of course, provides the pretext for government intervention. But governments fail, too. There is the problem of policy by special interests of the kind described above and the growth of middle class entitlements as described in a previous chapter. There is also the short-termism that neglects investment in long-term infrastructure spending and instead prioritises the spending on immediate “goodies” that can help win votes at elections. In a 2014 survey the economists Jim Gwartney and Rosemarie Fike analysed 23 of the most common economic textbooks used in America and found that they were, on average, six times as likely to cover market failure as government failure. Don Boudreaux of George Mason University notes that the New York Times economics columnist Paul Krugman did not mention government failure or public choice theory once in his introductory book to economics.
CORRECTING CRONY CAPITALISM
Crony capitalism will not be beaten back by any one policy. It will require sunset regimes for regulations so that they automatically expire after a short period unless there is a good case for them to continue. A broad simplification of the tax system so that well-connected industries can’t get special favours designed into the system. More teeth for competition authorities so that they can act against oligopolistic or predatory behaviour. Reform of patents. And, perhaps most importantly, limits on political donations.
Crony or phony capitalism reflects a corrupt form of entrepreneurialism. In The Great Divide Joseph Stiglitz identifies the capitalists who have found innovative ways of persuading the government to protect their market status: “socialism for the rich”. A clean up should include general limitations on the amount of money that business or wealthy individuals can donate to political parties and special prohibitions on donations during sensitive political times. 27 US states, for example, have stopped politicians from soliciting or receiving campaign contributions when legislatures are sitting. Unfortunately the big picture remains gloomy in the US. "The Supreme Court,” wrote Stiglitz, “in its recent Citizens United case, has enshrined the right of corporations to buy government, by removing limitations on campaign spending. The personal and the political are today in perfect alignment".
AND THEN THERE IS BRAZIL AND CHINA AND OTHER DEVELOPING NATIONS
This chapter has focused on the problem of crony capitalism in advanced nations. It is probably a bigger problem in developing countries. Here’s The Economist:
“Capitalism based on rent-seeking is not just unfair, but also bad for long-term growth. As our briefing on India explains (see article), resources are misallocated: crummy roads are often the work of crony firms. Competition is repressed: Mexicans pay too much for their phones. Dynamic new firms are stifled by better-connected incumbents. And if linked to the financing of politics, rent-heavy capitalism sets a tone at the top that can let petty graft flourish. When ministers are on the take, why shouldn’t underpaid junior officials be?”
Overall we have seen the wealth of billionaires in sectors characterised by cronyism double in relation to the overall size of the economy – from 2% of GDP in 2000 to 4% today. Developing countries, concludes The Economist, “contribute 42% of world output, but 65% of crony wealth.”
We know that unhealthy relationships between business and government can mean that bad practice is enshrined. In China, for example, according to research quoted in the Harvard Business Review, the rate of worker deaths is five times greater at politically connected companies than at similar companies that lack friends in high places. Brazil’s Petrobas oil company has become a perfect example of when relations between enterprises and politicians get too close. The Brazilian police are investigating allegations that senior managers in the country’s most important company diverted about 3% of contracts to the ruling Workers’ Party and its allies. This isn’t just a question of rank corruption. It has meant an incredibly important firm has been spectacularly badly led with investment projects mismanaged and money sunk in poorly thought-through schemes. One of the most important and neglected arguments for privatisation of state-owned or state-orbiting enterprises is that they cease to be politicised and they focus on maximising profits and, hopefully, purpose.
Postscript 1: Is there much that a capitalist could disagree with in Robert Reich’s short movie?
POSTSCRIPT 2: THE SOCIAL JUSTICE FUNCTION OF SMALL FIRMS
Ensuring that small businesses are not subject to unfair competition from bigger, politically-connected firms is not just in the interests of entrepreneurs and family-sized firms. It is also in the clear interests of some of the most vulnerable members of society. That is the conclusion of Tom Papworth of the London-based think tank, Centre Forum. He argues that the oft-repeated claims by politicians that small businesses drive economic growth and innovation may be overstated. He does discover, however, that small and medium-sized enterprises (SMEs) are most likely to provide work for the unemployed. Examining UK employment statistics he finds that “92% of movements from unemployment or non-participation into private sector employment are due to the individual starting up or being employed by an SME.” He continues:
“Those working in SMEs are more likely to come from groups that have experienced relatively more hardship during the recent recession. For example, young people (aged 16 to 24), people above retirement age and those without a university degree who move from worklessness to employment are less likely to find jobs with companies employing more than 250 workers than mature adults and those benefiting from higher education. Medium sized businesses in particular are responsible for a greater proportion of employment in areas of the UK with higher unemployment (i.e. not the South or East of England) and especially in the North East and Wales, which have amongst the highest rates of unemployment. High growth medium-sized businesses are particularly important to job creation. Whereas 65% of medium-sized firms achieve less than 1% employment growth, two-thirds of jobs created by medium-sized businesses emerge from just 6% of those firms.”
Minimising any and all unemployment should be a top priority of any government. It is not, after all, a temporary blight upon people. Mark Carney, Governor of the Bank of England has warned that “a rise in unemployment by 5 percentage points is estimated to imply an average initial loss of earnings for new college graduates of around 9 per cent, an effect which is estimated to fade only after a decade.” Even short-term unemployment can have long-term effects.
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