Cronyism: History, Costs, Case Studies & Solutions

Adam ThiererSenior Research FellowMercatus Center at George Mason University

November 2012

2

Purpose of This Presentation

1. Clearly define cronyism2. Discuss its historical / academic underpinnings3. Develop a taxonomy of types of cronyism4. Explain the dangers / costs of cronyism5. Identify notable case studies6. Consider possible solutions7. Offer additional resources

3

What is Cronyism?• Cronyism generally refers to an unnatural and

unhealthy closeness between government and special interests– “Cronyism is the substitution of political influence for free

markets” - David R. Henderson

• cronyism is a by-product, or subset of, a much bigger problem: government-granted privileges or government favoritism– Simply stated, someone is getting special treatment at the

expense of others thanks to political connections

4

Historical / Academic Underpinnings

Cronyism is a relatively new term• Traditionally, corruption was the primary form of cronyism

that concerned political scientists, economists, and journalists • But corruption is merely one extreme variant (or by-product)

of cronyism• We tried to address on type of cronyism in the 19th century

where government jobs were given to family members and friends through the Pendleton Act.

• Political scientists and economists have a long history of critiquing cronyism by other names…

5

Poly Sci & Econ Influences• Political science critiques

– “interest group politics”– “client politics” (James Q. Wilson)– “iron triangles” (Theodore Lowi)– “revolving doors”

• Economic critiques = “Economic theory of regulation” (which countered the “public interest theory” of regulation)– Chicago school: “capture theory” (Stigler) & corporatism

(Friedman)– Public choice school: “Rent seeking” (seeking of favors) &

“rent extraction” (granting of favors)

6

Common Themes from Critiques• First, when benefits are concentrated and costs are

dispersed (across all taxpayers, for example), we can expect groups to form to take advantage of those benefits.

• Those bearing the dispersed costs will have less of an incentive to form groups to counter those receiving the benefits.

• This explains why some government programs and regulations become so entrenched and why rent-seeking self-perpetuates.

• (These insights flow from Mancur Olson’s 1965 book, The Logic of Collective Action)

7

• Second, the “public interest theory” of policymaking and regulation is highly flawed.

• The notion that lawmakers and regulators are always enlightened and benevolent actors who would intervene to correct supposed market failures and “serve the broad social goal of maximizing social welfare” or other “public interest” objectives, is at odds with empirical reality.

• Quite often, the opposite is true: They often act to satisfy the private interest of politically favored players at the expense of the public.

Common Themes (cont.)

8

A Taxonomy of Cronyism1. Monopoly Privileges (ex: franchising, barriers to entry, exclusionary

rights)2. Regulatory Privileges (ex: licensing, limits on entry, price / rate

guarantees)3. Subsidies4. Loan Guarantees 5. Tax Privileges6. Bailouts7. Expected Bailouts8. Tariffs and Quotas on Foreign Competition9. Noncompetitive Bidding10. Multiple Privileges

Source: Matt Mitchell, “The Pathology of Privilege: The Economic Consequences of Government Favoritism” (Mercatus Center Working Paper, July 2012)

9

Dangers / Costs of CronyismSpecific Costs Monopoly Costs: “Deadweight loss” from lack of competitive rivalry. Productive Inefficiencies: When shielded from competition, firms get lazy

and less efficient. Unproductive entrepreneurship: Cronyism incentivizes firms to excel at

political entrepreneurship over market entrepreneurship Inattention to Consumer Desires: When shielded from competition,

organizations worry more about pleasing policymakers than the consuming public.

Distributional Effects: Consumers pay higher prices or get lower-quality goods and services.

Loss of Innovation and Diminished Long-Run Economic Growth: More cronyism = less innovation in general; can limit long-term growth potential.

As economist Gordon Tullock has summed up:

“Drawing the bulk of intelligent and energetic people in society into an activity that has no social product, or may have negative social product, is more important in explaining the stagnation of these societies than the direct social cost of the rent seeking...

…lobbyists in Washington… are very intelligent and energetic people… They are the kind of people we would like to have driving forward in production. Most, however, are on the other side — seeking special privilege. Unfortunately this collection of highly intelligent and energetic people who could make real contributions to society are reducing its efficiency.”

11

Costs of Cronyism (cont.)Big Picture / Longer-Term Costs• Undermines the legitimacy of the private sector / capitalism

– True capitalism is anti-cronyist by nature– True capitalism hinges on mutually beneficially gains from voluntary

exchange– Cronyism, by contrast, skews that balance in someone’s favor at the

expense of others– It is important to note that cronyism exists in every economic form of

society, including socialism and communism

• Undermines the legitimacy of government / democracy – lost “social trust”

• Moral hazard (reducing self-reliance / personal responsibility)

12

Case StudiesAgriculture• Sugar program• Ethanol programEnergy• Tennessee Valley Authority • Synthetic Fuels Corp.• Solyndra • Electric cars (Tesla)Financial sector• Fannie Mae & Freddie Mac• Wall Street bailouts

13

Case Studies (cont.)Defense• numerous “military-industrial complex” case studiesInfrastructure • Highway / construction programs• Stadium & convention center dealsIndustrial / Manufacturing / Trade• Auto bailouts • Steel tariffs (Bush) / Harley-Davidson protectionism (Reagan)• Ex-Im Bank • State-level economic development offices

14

Case Studies (cont.)Network Industries• Transportation

– Railroads – Airlines (protected cartels prior to deregulation)– Taxis (medallions; Uber restrictions)

• Telecom & Media– Telecom monopoly cronyist origins & “universal service”

programs– Broadcasting special treatment for over 80 years– Cable TV franchising laws

15

Emerging High-Tech Case Studies• Apple receiving tens of millions in subsidies and tax credits from Texas to

open a facility outside of Austin• Facebook is also getting tax favors from Texas and property tax

exemptions in Oregon• Twitter recently secured massive tax breaks from San Francisco to stay

there• LivingSocial recently cut a deal for approximately $32 million in corporate

and property tax exemptions in Washington, D.C. • Groupon received $3.5 million in an incentive package from Illinois• Motorola secured over $100 million in tax credits and incentives from

Illinois in exchange for a promise to keep its headquarters there• Movie & video game production incentives: hundreds of millions in tax

breaks and inducements now flowing to movie and game studios from states across the U.S.

16

Solutions (Part 1)

The Meta-Solution– The cronyism problem is inexorably tied up with

the size and growth of government– We will never completely constrain cronyism as

long as Big Government exists– So, the easy solution = cut the size & discretionary

power of gov’t whenever possible!

17

Solutions (Part 2)Targeted Reforms• Defunding or depriving those who received special treatment• Sunsets on programs and policies• Deregulation / end licensing & franchising rights• “BRAC”-like solutions when possible• Limits on congressional delegation of power to less accountable regulatory

agencies• Clear property rights & constitutional protections• “MFN clause”-like solutions & multilateral accords• Greater transparency / disclosure measures• Moral pressure & press attention to change social / market norms

18

Solutions (Part 3)Tell the Story! • Get the word out about the costs of cronyism and

these case studies • Again, moral pressure & press attention can help

change social / market norms and lead to reforms• We need to create a social stigma about cronyism

– Make it uncomfortable for companies to engage in rent-seeking

– Make it uncomfortable for policymakers to engage in rent-extraction

19

Mercatus Center Resources• “

The Pathology of Privilege: The Economic Consequences of Government Favoritism: - Matthew Mitchell (July 08, 2012)

• “Crony Capitalism: By-Product of Big Government” - Randall G. Holcombe (Oct 24, 2012)

• “The Economics and History of Cronyism” - David R. Henderson (July 26, 2012)

• “Gauging the Perception of Cronyism in the United States” - Daniel Sutter (Oct 17, 2012)

• “Government Cronyism and the Erosion of the Public’s Trust” - John Garen (Oct 11, 2012)

• “Cronyism & Capture in the Information Technology Sector” – Adam Thierer & Brent Skorup (forthcoming, 2013)

20

Additional Resources (Pt. 1)

• Gordon Tullock, Arthur Seldon, and Gordon L. Brady, Government Failure: A Primer in Public Choice (Washington, DC: Cato Institute, 2002).

• Mancur Olson, The Logic of Collective Action: Public Goods and the Theory of Groups (Cambridge, MA: Harvard University Press, 1965).

• Randy T. Simmons, Beyond Politics: The Roots of Government Failure (Oakland, CA: The Independent Institute, 2011).

• Fred S. McChesney, Money for Nothing: Politicians, Rent Extraction, and Political Extortion (Cambridge, MA: Harvard University Press, 1997).

• James M. Buchanan, “Politics without Romance,” Policy 19, no. 3, (Spring 2003), 13-18.

21

Additional Resources (Pt. 2)

• George Stigler, “The Theory of Economic Regulation,” Bell Journal of Economics and Management Science 2, no. 1 (1971).

• Sam Peltzman, “Toward a More General Theory of Regulation,” 19 Journal of Law and Economics (August 1976), 211-40.

• Mark Green and Ralph Nader, “Economic Regulation vs. Competition: Uncle Sam the Monopoly Man,” Yale Law Journal 82, no. 5, (April 1973).

• Theodore J. Lowi, The End of Liberalism: The Second Republic of the United States (New York: Norton: 2nd Ed., 1969, 1979).

• Adam Thierer, “Regulatory Capture: What the Experts Have Found,” Technology Liberation Front, December 19, 2010.