Simon Says --- Crony Capitalism in the Financial Sector

| Peter Boettke |

Simon Johnson is an astute economist.  That observation is not just from following his commentary at The Baseline Scenario.  No, Johnson demonstrated his skills early in his career with his analysis of Soviet and post-Soviet affairs, and then in his work in the 'institutions rule' debate.  So it should be no surprise that he has had very valuable things to say throughout the contemporary discussion on the financial crisis.

But I think in this context, it is also important for those of us who strive to communicate to our scientific peers, with students, with policy decision-makers, and the interested public to be extremely clear.  Emotion and passion are ready to substitute for reason and fact at every turn in the ongoing discussion.

Simon is correctly outraged by crony capitalism and the willingness of government officials to use the hard-earned financial resources of the taxpayer to bailout the bad behavior of the politically favored.  But many readers of Simon's commentaries (on his blog and in the NYT) confuse an indictment of crony capitalism with an indictment of "profiteering" in general.

Many of us are concerned with the idea of "Saving Capitalism from the Capitalists" --- and the tools at our disposal for such a critique of political capitalism are provided by the rent-seeking theory of Gordon Tullock, the economic theories of regulation provided by George Stigler and Sam Peltzman, etc., etc.  That businessmen will curry favor with those in power to strategically use government for their private gain was recognized by Adam Smith, and in fact, is one of the major reasons why thinkers such as Smith and Say were so anti-monopoly in their works (important point: monopoly is not a market phenomena, but a consequence of a government grant or privilege that provides for exclusive rights to be a seller of a particular good or service).  More modern economists such as Yale Brozen and Murray Rothbard made similar points about the government being the source of monopoly.  Even Bill Baumol recognized that antitrust policy could be used as a strategic tool by rival businesses to protect their enterprise from competitive pressures.

Political capitalism, or crony capitalism, must be exposed for the corrupt and unjust system it is, but true capitalism -- a system of private property rights and freedom in exchange and production -- is neither corrupt nor unjust.  In that world profiteering is not to be condemed, but respected as a worthy pursuit of free individuals -- an act fully consistent with human dignity and living a flourshing life.  Profit seeking in this world of true capitalism does not entail the use of the coercive power of the state to secure financial resources to a priviledged elite, rather it entails the businessman to constantly be on alert for better ways to satisfy customers and better ways to produce the goods and services he is providing to customers.  Higher quality, lower prices, and more of that, is the tendency in the free market.  Nothing immoral about the businessmen earning a profit providing that for us.

Long term value creation deserves our respect, political profiteering deserves scorn -- lets make sure we are clear in our language and analysis so readers understand the difference.

Comments

[Lee Kelly]

Capitalism comes in many flavours. Milton Friedman sometimes made a useful distinction between capitalism and competitive capitalism.

[Rob Bradley]

My website www.politicalcapitalism.org contains some definition and terms that might be of interest.

Thanks Pete--the check is in the mail.

[Rafe Champion]

The distinction between market entrepreneurs and political entrepreneurs is helpful, as demonstrated by Tom DiLorenzo on the so-called robber barons of the gilded age.
http://mises.org/story/2317

[David Pontoppidan]

Pete,

Great post, especially the point about long term value creation.

What do you think about the argument put forth by many politicians, and some economists, that the bonus salaries of investment bankers and traders in the financial sector has created an institutionalized immorality which drives employees to ignore rules and break laws in their pursuit of obscenely large profits, thereby contributing to destroying the financial system?

I'm asking because the EU heads of state just met this week and agreed that because of this, federal EU legislation must in the future limit bonus payments to a certain amount, because the market cannot solve the situation by itself.

Best,

David

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