A Discussion on Crony Capitalism

“Crony Capitalism” is a politically-charged term that is often tossed around regardless of its meaning; some actions that are decried as “crony capitalist” are not and some that are defended against the charge are.

Let’s begin with a definition of crony capitalism.  Crony capitalism is not more than the merging of business and political interests.  This can be done through regulations (using regs to limit or drive out competition), special tax breaks, subsidies, tariffs, etc etc; essentially whenever government interferes in private business on behalf of a party or special interest group.*

What’s important about the above definition of crony capitalism (which can be obtained via a simple Google search) is that it makes no difference whether the outcome of such crony capitalist interventions are net beneficial or net harmful.  Many people attempt to justify (or defend against the charge of) crony capitalism by arguing such intervention has net-beneficial results, or sometimes just that they have beneficial results.  Planned Parenthood, trade tariffs, green energy subsidies, and HUD subsidies are often justified under this argument.  But, as we discussed in the last post, all things have benefits (and costs).  The fact of their existence does not justify/condemn a particular institution or program.  The interventions are still crony-capitalist, even if they produce a net benefit.

Another important takeaway is that one’s intentions don’t come into play.  Whether these interventions are taken for the “greater good” or for one’s own personal gain is irrelevant.  One may be more despicable than the other, for sure, but that is a moral judgement call.

With the establishment of what crony capitalism is, let’s now talk about what it isn’t.  Crony capitalism is not the use of business practices one may dislike.  For example, a firm selling below cost to gain market share is not crony capitalism.  A firm buying up lots of Resource X to limit its use by competitors is not crony capitalism.  A union negotiating with a firm for a “closed shop” is not crony capitalism.  In order to justify the charge, one must show some form of government involvement (for example, by government license, a firm has exclusive first rights to purchase Resource X).

The distinctions here are important because in the public discourse crony capitalism is often used as a pejorative (and rightfully so, in my opinion).  However, not everyone believes crony capitalism is a pejorative.  In fact, many people support crony capitalism when they’re the ones benefiting from it (quelle surprise).  The charge is often levied against one person in order to discredit him or his policies, without regard for what the term means.  I hope to change that.

*I want to stress that, while the terms are often used interchangeably, this is not the same as socialism or communism where the government nationalizes firms or industries.  Public education in the United States, for example, is not crony capitalism since government owns and operates those schools.  Furthermore, the fact the government is willing to operate at a loss with these enterprises is not crony capitalism.

Today’s Quote of the Day…

…comes from Armen Alchian’s 1961 RAND Corp. publication Some Economics of Property, as reprinted on page 43 of the Liberty Fund edition of The Collected Works of Armen A. Alchian: Vol 2: Property Rights and Economic Behavior [original footnote]:

I should, I suppose, avow at random intervals that all this is not a condemnation of public ownership any more than certain “deficiencies” of marriage, the human eye, the upright position of the human being, or smoking are to be regarded as condemnations of marriage, eyes, walking on two feet, or smoking.  The “lesser” evils in some institution – and they exist in all – are borne for the greater good in some of them.  We are not arguing that private property even in its purest form is perfect in the cost-bearing sense.  No standard of perfection is available.  All of our statements have been comparative in degrees of cost bearing.

The converse of this “apologia” is that others should not speak of the imperfections of the marketplace, either.  Nor should they assume that in those instances where the marketplace is inferior in certain respects to, say, public ownership or government control, we should switch from the market to the government.*  The presence of one kind of relative deficiency does not simply justify a switch to another agency which has other kinds of deficiencies.  We can’t have either agency without also having all its attributes.  We repeat that this neither justifies nor condemns more private or more public ownership, more market- or more government-directed activity.  All this may help form such decisions, but it is only part of the story.

*We are mindful that rabbits have greater skin-healing power (even for some especially large [100cm^2] sizes of skin injury) than do human beings.  Should we deduce that rabbits should be used as soldiers?

Alchian’s point is an important one, but one oft-lost, even among economists: there are no solutions, only trade-offs.  Everything is subject to the question “as compared to what?”  There are no silver bullets and institutions form in response to their surroundings (and their surroundings respond to the institutions).  The mere fact a given institution has deficiencies is not a reason to replace it; its replacement will also have deficiencies.

On (Im)Perfect Subsitution

Another Econ 101 mistake people make, especially with regard to immigration and international trade, is some form of “foreigners (immigrants) can do all the work we do but for much lower prices!  Without subsidies/tariffs/minimum wage, they’re just going to take all our jobs!”  Other versions of this include “if a bunch of immigrants enter the nation, they’ll drive down wages!  Law of Supply and Demand!”

Both the above arguments make the same mistake, namely they assume foreign labor is a perfect substitute for domestic labor.  They treat all labor (or all low-skilled labor) as a homogeneous blob, one part easily replaceable with another.  But, alas, that is not the case, as price theory can show us.

Looking simply at the wages of laborers, we should ask the question “why do immigrants/foreigners command lower prices than domestic workers?” The fact that there hasn’t been wholesale replacement of domestic labor with foreign means we can rule out any cultural/biological/cost-of-living reasons such as “lower cost of living in 3rd world” or “they have a lower standard of life and thus demand lower pay” etc.  If this were indeed the case, domestic companies could just pack everything up and ship it overseas (that is, stuff that can’t be staffed by immigrants) and make tons of profits (while I have no doubt some people believe that is what is happening, the data say otherwise).

What’s more likely is that foreign workers and immigrants are simply less productive than domestic workers.  Immigrants coming into the country, legal or otherwise, face major barriers, not the least of which is the language barrier.  The manager at McDonalds cannot simply fire an American order-taker making minimum wage and hire a foreign worker for half the cost. The foreigner, simply by virtue of not knowing the language, will be less productive, thus his lower salary.  A similar argument for offshoring can be made: foreign workers, by virtue of less capital augmentation, will be less productive and thus command lower salaries.

In short, foreign workers/immigrants are not perfect substitutions for domestic labor!

It may make sense for some firms to replace/augment domestic labor with foreign labor, but the mere fact it is cheaper is not the reason why.  David Ricardo’s powerful idea shows there are times it is prudent to replace more productive resources with less productive resources, but to do so on a large scale with disregard to opportunity cost is a recipe for disaster, and why firms and individuals do not do it.

The Myth of Perfect Allocation

Most economics principles textbooks have some version of the supply and demand chart below:

supply-and-demand-graph

Just your simple equilibrium analysis.  Unfortunately, misunderstanding this chart can lead to comments like this one from Mark Perry’s blog Carpe Diem:

Matthew D:

If the minimum wage causes unemployment because wages are set by supply and demand, and the minimum wage exists above the market clearing wage, this implies that market would clear without a price floor.
In other words, without a minimum wage we would have full employment.  So, the US before the passing for the Fair Labor Standards Act of 1938 had full employment, eh? Full employment was the norm?

What’s incorrect about Mr Matthew D’s comment his his implication: “that markets[s] would clear without a price floor.”  Price theory teaches us no such thing.  No price theorist claims that, absent price controls, markets will always clear (that is, quantity supplied equals quantity demanded).  Rather, that price theory, what the above chart (and subsequent price control analysis), does teach us is that, absent price controls, markets move toward a market-clearing equilibrium and price controls prevent such movement.  In other words, absent price controls, markets work toward the most efficient allocation of resources.  Price controls prevent such movements.

Price theory teaches us as compared to price controls, market allocation will be more efficient than price-control allocation.

Markets are not perfect.  That’s why we need markets.  Markets incentivize people, in ways central planners do not, to find and eliminate these imperfections.Not enough water delivered to area X?  Price of water rises, incentivizing people to bring water to that market, thus fixing the imbalance, for example.  To paraphrase one of my all-time favorite economists and writers, Steve Horwitz, markets exist because we were kicked out of Eden, not because we’re in Eden.

Trump’s Immigration Plan Cannot Make America Great Again

The other day, I wrote how Trump’s tariff plan cannot make America great again.  In that post, I promised a follow-up on immigration.  This is that post.

A quick note before I begin: many people will likely object to this post because of various social problems immigration may bring (they’ll vote away our freedoms, they’re violent, they suck welfare, etc).  I, and many others far smarter than I, have addressed those myths in the past and I will not reiterate those arguments here.  This post will focus on the economics of immigration.

Continue reading

The Importance of Well-Defined Property Rights

Resources are scarce. This inevitably means conflicts will arise.  Here is one such example following a snowstorm in Boston.

In this case, the property right is well-defined.  The “space-saver” has no right to the space: “Space savers are prohibited in the South End [of Boston].”  He has no right to prohibit use of the space to other people; in fact, the other person has the right to sue the space.  Should the space-saver make good on his threat, he would rightfully be punished.

However, if there were no property rights, or if they were ill-defined, then the conflict could and likely would persist if not escalate.  Would the space-saver be in the right to defend the space?  Or would he be in the wrong?  Lack of any kind of guidance on the issue would prevent the creation of more parking spaces (which Lord knows Boston needs).

There is another element to this story I’ve not explored.  This whole time, I’ve assumed that the legislation governing the allocation of parking space property rights aligns with the law of parking spaces (that is, the customs governing their use).  If this is not the case, however, we see how legislation can actually make a conflict worse.  Let’s, for the sake of argument, assume this situation now.  Let’s say the space-saver is acting according to the law, which is whoever places something to save a space prior to a snowstorm can park in that space after/during (I know this is the unspoken, but very real, rule in North Boston). Therefore, the space-saver was acting within his expectations of a right.  In the eyes of the law (again, not legislation) he was in the right!*  The legislation, then, is attempting to override the law, which can create more conflict, rather than eliminate it!  Legislation is not the only way to define property rights.

One final parting thought: This conflict between the space-saver and the driver who parked there may be indicative that the current property right regime is inefficient for the current situation.  We may have institutional failure.  However, one should not try to read too much into the situation from this one conflict.  Institutions can and should be difficult to change, and there will always be scofflaws.  No system will eliminate conflicts, but when conflicts arise it may be an indication of the need for institutional change.  But the presence of conflict is not sufficient reason alone to change.

*His behavior is over the top, to be sure