Why Crony Capitalism Hurts Us All

The summer showdown over the Export-Import Bank, which ended in something of a stalemate in September, as Congress authorized a nine-month extension of the bank’s authority, brought to center stage a mounting discontent—on virtually all sides—with the increasingly codependent relationship between business and government. Ex-Im Bank, which in fiscal year 2013 backed $37.4 billion of U.S. exports worldwide (about 2 percent of all U.S. exports), has since become a battered symbol of cronyism. According to the Heritage Foundation, fully two-thirds of Ex-Im financing benefited a single company: Boeing.

“More than half of the U.S. public said “strong and influential” corporations are “bad,” even if they are promoting innovation and growth.”

Analysis by the Mercatus Center at George Mason University further concludes that the top 10 companies supported by Ex-Im, which include Caterpillar, GE and Applied Materials, accounted for 97 percent of the loan guarantees made in 2013. Meanwhile, critics of the bank argue, the risk for the financing is borne largely by individuals; taxpayer exposure for Ex-Im’s loan guarantees is expected to exceed $140 billion by the end of 2014.

“It’s the quintessential example of cronyism,” says Veronique de Rugy, senior research fellow at the Mercatus Center at George Mason University. “Ex-Im is relatively small but serves primarily very large companies; and in the process, it creates a lot of distortion in the capital markets. It also creates a totally [uneven] playing field because there are just a few exporters getting subsidized, while most are not. So, essentially, it’s the government picking winners and losers.”

Boeing, for its part, claims that without the government support, it would be at a competitive disadvantage vis-à-vis foreign competitors that receive state support. But in a climate of cronyism, it’s a zero-sum game; providing cheaper financing to foreign competitors puts U.S. companies at a disadvantage, as Delta CEO Richard Anderson has pointed out numerous times. “I don’t understand why my government finances my state-owned enterprise competitors in foreign countries that really are governments, not airlines,” Anderson said in July.

The problem is hardly limited to Ex-Im. Concerns about giveaways to connected corporations have reached a boiling point, generating more and more controversy and outcry on both sides of the political divide. Conservatives point to examples like Ex-Im and Solyndra, the California-based solar company that went bankrupt after receiving $535 million in federal loan guarantees, while progressives point to special subsidies, tax loopholes and powerful lobbying by wealthy  companies, such as Boeing and General Electric as evidence that the relationship between government and business has crossed the line well beyond benign partnership.

“The whole notion of meritocracy has come under attack and has been displaced by notions of cronyism or kleptocracy or something similar.”

Meanwhile, the average citizen, soured by declining real personal income, has become increasingly cynical about what he views as neo-mercantilism or crony capitalism that appears to benefit the elites at the expense of ordinary people. According to a new global survey, the CNBC/Burson-Marsteller Corporate Perception Indicator, the U.S. public is divided on whether corporations are a source of “hope” (36 percent) or “fear” (37 percent), while in China, 84 percent say corporations are a source of “hope.” More than half of the U.S. public said “strong and influential” corporations are “bad,” even if they are promoting innovation and growth, while in China, 74 percent embrace strong corporations as “good.”

Some of those feelings may be due to cultural differences, but not all. And perceptions, even flawed ones, can have unfortunate consequences for business, even those whose commercial interests have little connection to government.

A Pervasive Problem
Cronyism, hardly a recent invention, has ebbed and flowed over the decades, but it appears to be on the rise today. “The whole notion of meritocracy has come under attack and has been displaced by notions of cronyism or kleptocracy or something similar,” says Jonathan Macey, Sam Harris Professor of corporate law, corporate finance and securities law at Yale Law School. Examples of corporate welfare abound—from energy tax breaks and fast food subsidies to endless patent protection for big pharma and bailouts of behemoths pulled back from the brink by Uncle Sam’s long and generous arm. The Cato Institute estimates that federal subsidies to corporations cost taxpayers almost $100 billion every year.

Sadly, only a fortunate few benefit from this largesse. Small and midsize businesses lack the lobbying funds or personal coffers to make huge campaign contributions and therefore have little power to sway legislation. “Even if you’re a profitable, midsize business, if you’re talking about an outlay for one lobbyist coming in at $250,000 a year—and you need three or four of them at least, that’s a bit of a problem,” says Nick Sorrentino, editor of AgainstCronyCapitalism.org, who says the uneven playing field is analogous to high-stakes poker.

“If the minimum to get into the tournament were $20, that would be fine. But with the big companies, GE and Boeing, it’s $10,000 just to get through the door. A lot of the people who have chips, who want to play and want to parlay that [stake] into becoming a large company, they’re not even allowed in the game. It really is pay for play.”

The lopsided distribution of power in the field is evident in the uphill battle faced by innovative startups that find themselves besieged by new regulations that inhibit their growth. “Cronyism destroys innovation,” Sorrentino says simply, pointing to Uber and Airbnb as recent examples of disruptive companies that have faced numerous municipal and state regulations designed to hold them back.

While local regulators do have some legitimate concerns for safety of consumers’ using ride sharing and individual room rentals, it’s hard to tell how much of the reflexive regulatory action is owed to those anxieties and how much is a salve for lost municipal tax revenue and the economic bite for well-connected, traditional hoteliers and taxi and limousine companies. Tesla Motors has been locked in battle with the New Jersey Motor Vehicles Commission over the rights to sell its electric cars directly to consumers, bypassing franchise dealerships. In April, New Jersey passed new regulation prohibiting such direct sales. Tesla CEO Elon Musk accused Governor Chris Christie of bowing to pressure by the state auto dealership lobby, which argued that Tesla’s factory model creates a “vertical monopoly and limits competition.”

In his blog post on the subject, Musk notes that “the rationale given for the regulation change that requires auto companies to sell through dealers is that it ensures ‘consumer protection.’ If you believe this, Governor Christie has a bridge closure he wants to sell you! Unless they are referring to the mafia version of ‘protection,’ this is obviously untrue. As anyone who has been through the conventional auto dealer purchase process knows, consumer protection is pretty much the furthest thing from the typical car dealer’s mind.”

Too Big to Fix?
Part of what perpetuates the problem is that those companies that have achieved enough size and influence to upend the system aren’t really motivated to do so because they benefit from that very system. Those business leaders wind up saying one thing but doing another. Consider CEO Charles Koch’s 2011 op-ed in The Wall Street Journal decrying cronyism and corporate lobbying for special favors. Yet Koch Industries spent more than $10 million lobbying in 2013 alone on more than 60 energy-related bills, according to government watchdog OpenSecrets.org.

“You have this strata of businesses at the very top of the economy who form a kind of crust, and the dynamism of the economy, the thing that keeps it going—competition, entrepreneurialism—begins to die off.”

And they’re not alone. “Everybody points to the Koch brothers and tries to make them look like super, super bad guys,” says Macey. “The fact is that you’ve got massive amounts of political activity going on by all sorts of special interest groups. We would have to stop all this stuff by everybody.”

In other words, companies of all sizes, even those who seem to benefit from the kindness of congressmen, would have to recognize that if cronyism is bad for some, it’s bad for all. “The problem we’ve had is that you have this strata of businesses at the very top of the economy who form a kind of crust, and the dynamism of the economy, the thing that keeps it going—competition, entrepreneurialism—begins to die off,” says Sorrentino. “It’s like an algae bloom on top of the economy. There’s no oxygen reaching down into the economic lake. It works for Boeing and GE, but that’s just short-term thinking. Eventually it will kill them, too.”

This is why Sorrentino and others believe the only way to fix the system is to dismantle it—because if there is no system, there is no way to game it. “Get rid of the regulations, get rid of government programs, get rid of the tax loopholes,” says Randall G. Halcombe, DeVoe Moore professor of economics at Florida State University and author of Producing Prosperity. “The smaller government is, the fewer favors it can bestow.”

Dismantling the system might not be achievable in the near-term, but the climate of discontent is growing and is no longer a right vs. left issue. “One interesting thing about this backlash against cronyism we’ve seen over last five or six years is that it really spans the political spectrum from left to right,” Halcombe notes. “The critiques of cronyism come from all over the political spectrum.” Indeed, the subject has become increasingly divisive even within the GOP, as evidenced by Congressman Eric Cantor’s June primary defeat in Virginia to Tea Party challenger, Dave Brat, which sent Boeing’s stock tumbling. Cantor, well connected to the big-business wing of the party, was a staunch supporter of
Ex-Im Bank.

“This [relatively new] branch of the Republican party seems to really believe in free markets,” says Arthur MacEwan, professor emeritus of economics at the University of Massachusetts Boston. “The establishment likes to talk about free markets, but many of the policies don’t support it.” One of the clearest examples, he says, is the bailout of the banks that caused the mortgage-lending crisis. “Yes, if you’d let those banks fail, it would be damaging to all of us. But it amounts to a subsidy, a way they can get capital very cheaply. They’re then able to influence the regulations, and those allow them to operate just the way they were operating before.” If protectionism were eliminated, if companies had to face consequences and risk, they might behave more responsibly.

But in the near term, small and midsize company CEOs must compete as best they can, eschew any opportunities to benefit from cronyism, and speak out on the subject. Business leaders also have to do more to change Main Street’s perception of business. “The perceived linkage between business health and middle class prosperity has been substantially weakened” because of the recent financial crises, says Nick Pinchuk, chairman and CEO of Snap-on, a Fortune 500 manufacturer of shop equipment products and automotive diagnostic tools. “We have to do more to educate the public, to reinforce the notion that if companies do better, it’s better for the community. As business leaders, we recognize that we are stewards of the investors’ capital, but we also are stewards of the prosperity of the middle class, and we have to act that way.”

Sidebar: Standing on Our Own

C.J. Prince :C.J. Prince is a regular contributor to Chief Executive and other business publications.