If real capitalism exists, is it sustainable? Or does capitalism in a democracy always devolve into corporatist cronyism? In this talk, Mario Villarreal-Diaz discusses how free markets may have a tendency towards cronyism, how the democratic political process makes this trend worse, and what can be done to mitigate emerging related problems.
- Mario Villarreal-DiazManaging Director, Red McCombs School of Business
Welcome to the Policy McCombs podcast, a data driven conversation on the economic
issues of the day. In this series, we invite guests into our studio to provide a highlight
of their work presented during a visit to the University of Texas at Austin Policy. Emma
Combs is produced by the Center for Enterprise and Policy Analytics at the McCombs School of Business.
Our guest today is our co-host Mario Villarreal, Diaz CEEP as managing director and
senior scholar. Mario joins SIPA this best January from the University of Arizona, where he was
an associate professor at the Department of Political Economy and Moral Science. Mario, welcome to Policy McCombs.
Hi, Carlos. Happy to be here. So our conversation today will focus on your recently published paper
coauthor with Mike Munger from Duke University. The Road to Crony Capitalism. So let’s start with some some definitions.
So what do you mean by crony? And describe to us the road you see? Well,
cronyism is a situation where it would be useful to first
think about it, the absence of cronyism and the absence of cronyism, the way
firms make profits. The word companies advance their interest
in a free market society is by creating value for consumers.
Right. I’ve you want to gain the favor of your consumers.
You make better products. And of course, there is a process that will
facilitate that outcome of better products, namely that you innovate, you invest
in R&D, you discover or invest
money in discovering better ways to assembly your product. And that way
you impact prices and somehow. But the proposition is about value creation. Right.
And in the in in in a company competitive market, there are several firms and several
players in that in the field trying to do the same. So that’s good for the consumer. So
the value proposition here is making consumers better off
by offering them better products. That’s in in
that’s what happens in a free market. However, that’s not the only way that you could
increase your profits and do better in the market.
Another way would be to gain some sort of a special privilege
normally from the state that will shield you from competition.
It would be something like a subsidy or. Very entry
or a grant. Some think that will not be a bailable
for others. Competitor, auto competitors, but only yourself, and by virtue
of that special privilege, you have an advantage over orders. And
therefore the way you gain consumers favor is not any more value.
Only a value proposition is more grounded or rooted in that
especial privilege. So that’s cronyism. Cronyism is seeking
activities that are involved in seeking and obtaining that a special privilege
from the state. So the availability of rent seeking behavior essentially from companies,
typically from the state, typically from from from governments and through laws that allows them to
have the special privileges. That is correct, that the technical term is rent seeking. So
so OK. So that’s what you mean by crony. And so what is this road that you described as road
the capitalist road to cronyism? Well, the paper that
Mike Munger and I wrote was motivated by
Hayek’s observation in the Road to Serfdom, that once you start planning
certain sectors of the economy, the distortions that you create are going to require more planning
to be remedy. And then that is going to create in toward more distortions and then it’s going to be require more planning.
So is a path or a road to a more and more
centralized planned system or process or economy.
Hayek identified this tendency once you start walking down that road. So what we wanted to
do is or what we were strike by that it seemed that they may be a tendency within free markets
towards cronyism. And the tendency is fueled by a couple of things
on one part, this the same the very same dynamics
of competition that we highlight as positive because it creates value for consumers,
because one of the outcomes of that is that he makes harder for companies to obtain profits.
Right. They compete and compete and compete is harder to innovate is more costly
to innovate. The returns of investment on innovation and research and development are more and more uncertain.
So the profits start to dissipate. And that’s not the only way you can get
profits. You can also get profits if you actually seek that a special privilege. We’ve talked before.
On the other hand, it seems that it will be profitable for
politicians and for agencies to actually be in the business of granting those special
privileges. So you have a perfect match. You have a mutually beneficial transaction.
And that is the road to cronyism that Mike and I identify in in the paper is possible
to think that there may be a tendency within free market fueled by the free market
dynamics of competition and the political process in democracies that may
lead us to worse cronyism, more and more crony. So that’s not specific to democracy.
That could be a that’s a that’s. Any other system of government would would have the same ability
to provide those favors. And in fact, the one that’s more extreme on theirs is a socialist system
where things only get done by favors. So so so there’s no other vehicle
for you to get a grant of some privilege from the state? Correct? That is correct. There’s two great points there. Carlos,
what? One point is that one point is you’re right. I mean,
a democracy is not unique in in the sense that is the only system that will grant
special privileges to rent seekers. Maybe what is unique is
the process that allows the manifestation of very different voices in multiple voices
in in in the political process to actually advocate or pursue their
own especial narrow interest. And we can impact that a little bit more if indeed it
is, Mike. You’re also on the logical collective action. And Mark, you’re also on the recent decline of
nations where Badwater observation that that you make that I believe
is is important is that it’s always good to ask yourself compared to what
what is the tradeoff? Right. And certainly there may be
a road to cronyism embedded within free markets, but I do think
that is by far the best path that we have at creating prosperity
and a peaceful society, a prosperous and peaceful society. I mean, the argument
here is not to abandon free markets. The argument here is actually to be aware
of its potential flaw. So we protect it to protect and nurture
it. Right. Like because alternatives are much worse. Our system is a system of
actually like a small group of individuals. Normally seen violent coercion
to strike resources from orders. So, yeah, there are worse things than
than the path. So let’s let’s summarize the argument a bit. So in a very
soon in simple terms, you can you’re basically saying that the return on the marginal dollar
for a company in a very competitive space might be larger
by using the dollar on on seeking privilege from the government than
using the dollar to seek to improve their products through R&D or improvement in their processes.
Right. That is why it is more profitable to hire lawyers and lobbyists than engineers and
scientists. And that that you suggested is something that you see as at a later stage
of a certain industry, not necessarily in the beginning, but when you know there’s a very competitive environment
already, where then maybe the profits are now large enough to continue to innovate
in that direction. And seeing protectionism seeking sort of favor is going to be the best way to do to invest
the next the next dollar. That is correct, that the hypothesis will be that as industries mature
in that competitive process, that will be the case. So let’s think about some examples to to make this a
little real. What what would you identify as a company that you see that you know, or an industry that tends to,
two, to behave that way and as a case study for us to think about? Well,
the evidence, if you take a look at it, the companies that invest
heavily in lobbying nowadays are those in the health care
spectrum, including pharmaceutical companies. Right. That’s I
guess that’s that’s that will be a good example. Right. Like in pharmaceutical innovation is hard. Now,
there is another distortion there that may require
a separate treatment, which is why is innovation in the pharmaceutical sector
so hard and so costly in part is because discovering new stuff is
is a challenge. Right. But also partly because navigating the regulatory apparatus
that is required to approve a new drug or a new medicine is
very, very costly. But that would be a good example, right? Like like competing for that
market, the space only by using innovation
at some point, maybe not as profitable as at least combining it
or not. Or even just resorting to to special privilege. So
they seek, for example, to get extra protections in their patterns or extend the longevity
of some of some, but protection on on some some rights on a certain
drug, given that they found a new thing, maybe a new use for it. So on the basically trying to use that
engine to protect their market share, you know, for the longest possible and again, the government is the engine that allows us
making them to do that, making marginal changes to the formulas. And that’s a new pattern
and things like that. Now, again, this highlights a very important point. I think that
probably a Mike and I should have spent a little bit more time in this paper,
maybe a separate paper, which is it seems that
using this example that we just construct.
Innovation and a special privilege are not necessarily substitute
strategies that can be pursued at the same time they complements
their complements and the degree of complementarity.
Maybe in a question of empirics. All right. Actually, all those questions are empirical questions.
And you know that at CPI with us where where we like to or playground to be.
So the narrative is interesting, but there are empirical questions. So give me some examples. I guess you
know your talk today. I happen to have senior slides. You’re gonna give us some some numbers on on
on some measures that might give us a sense that we are making steps on this
road. So what are the types of things that that that you’re gonna tell us about? Well, for example,
I mean, like you said on the spending to get a special privilege
side from the 1970s to today,
expenditures and lobby has more than doubled. And we’re talking about sizable
expenditures like. On on the margins
of 3.5 billion dollars or so now on the granting of special
privilege, the amount of federal subsidies has more than tripled
in the same time span, and that’s transfers as money transferred
and out of corporate corporation to corporations like corporate welfare. Right. That’s money transfer
and that all is also overlooked looking. Another aspect that also deserves its own treatment,
which is is not the only way that a special privilege can be granted. Of course, monetary transfer
or corporate welfare is the obvious one. adobes one. But the regulation
is perhaps not so obvious one. And in that landscape, there is great work
done at George Mason University. The Kuan
gof slashed WREG data project on Mercatus with our friend Patrick McLachlin
that is trying to quantify the growth of regulations and various impacts that that may have
in various performance measures. But in that regard, we also have seen and
notable increase in the amount of regulations enacted in that very same time span. Now
the question isn’t political. The main hypothesis of the paper is very simple. If we will have
a simple model on the left hand side of the model O or the thing to be explained
would be some sort of cronyism measure like subsidy
of regulation, some sort of a special privilege measure and the right hand side. We should have some controls,
but then it will be or hypotheses about innovation. If innovation gets more costly like
the number of patents or rates of productivity, some sort of industry
maturity measure, we should see an inverse relationship. And that’s the next step.
That’s that is the next step. Right. So let’s go back to more
sort of institutional set up of the system that we have that perhaps allow for this. It seems to me that the road
this road is only possible as we expand the role of government as originally
defined by it, by by our Constitution. So, you know, the Constitution have very specific provisions
of what the government was allowed and could do. And through the years, by being a
living document and some as some like to say, and that has expanded dramatically
its role. I mean, if you look at the size of the federal government in the early 90s, hundreds were talking about
something that would encompass, I don’t know, three to five percent of the of the of our economy.
And now it’s something of the order of 28, 20, 30 percent of our economy. So that’s
a huge expansion on the role of government. And with that expansion, you get you get the ability now
to grant those those those favors, the ability to create the system of of
corporate corporate welfare that you describe. So is it is it
the capitalist system or is the political system? How do we how do we unpack those two things? How do you separate
the the how we allow how we know as a society we decided that
our government will take this role. And by making the government take that role, the political economy
aspect of it creates an enormous opportunity for. I guess what I’m trying to say is that
is it the rent seeking business behavior that’s driving this or is the power grab politicians favoring
this road to cronyism? Well, that that’s that’s an interesting question. I mean, you remind me
of I if I. I hope I’m correct. I’m not a constitutional expert.
I’m I’m not a constitutional expert in my Mexican constitution, Mexican. But even
if we do an if it even less so in the American cause. But
I think it was Madison, the one that said that first you need
to empower government to do what you specked government to do. But then you have to constrain
it. So the boundaries of it don’t get out of control. And
that’s a difficult proposition to balanced the political process in itself,
especially. And again, I mean, this is not unique in a democracy, but especially in a democracy by allowing
different voices to express themselves and different groups to organize, which is a
good thing. It’s a good thing. But that also means that you’re not only going to have the groups that
are going to get organized to advance virtuous or morally praiseworthy
or valuable objective. You also are going to have the ones that are going to get organized
to strike resort as role models. And you see that all the time and you have concentrated
benefits and it can spread out there costs. Absolutely typical. And the typical problem is this is a typical public
choice problem. And if it’s in also in the
interest of politicians to grant. Those special
privileges. Then you have a mutually beneficial transaction. Now, I think that the worst thing that
can happen to a society is the collusion between political power and economic
power. And I think some of my friends, some of our friends in the left have a point
there. And the point is that is is not rare, as is it could
be the case that powerful people, economically powerful economic actors may
use her influence and power to actually tweak the rules and change the rules
in ways that are beneficial for them at the expense of others. Right.
How do you go about that? I mean, this dynamic, sorry, limiting step by these dynamics may be fuel
from both sides. How does this start? I think
the short answer is I don’t know. The longer answer is that it seems to me that
probably. Is the fact that the government can grant special privileges
that starts to fire. That will be
if I have to choose. If you force me to choose where these dances started,
then it starts with the possibility of the state.
Granting a special privilege so, you know, I. It’s
easy to point to a greedy corporations as a as a oh, yes, they are going to be the ones trying to
grab those favors and and those awful lobbyists in Washington and so on. But
we forget that there are people. Right, which we will like you and me, that are acting in their own self-interest.
And I was like to drop our lives thinking about this this morning where
I don’t see that behavior any different in the behavior of the not in my backyard folks right
there trying to extract favors from their local governments to say that
to protect the value of the property and, you know, to guarantee things that they did not buy in a contract
that they first engage with in order to get their house in and out by a certain amount of traffic in a
neighborhood, not by a certain amount of trees in the neighborhood. They bought the plot or the houses.
And yet they tried to use all their powers, political powers, essentially to
go through that, their local governments to try to say, no, no, no, nobody can come around here or build
more or because we don’t want more traffic. We need to protect the children. We need to protect the environment around
us, so on and so forth. So I don’t want to make a a moral
statement about that attitude, but I think it’s a very typical human attitude to protect the status quo,
to protect what you have. And and and, you know, we have to counteract that. You know,
in our public choice arrangements with our institutions in order to avoid the natural behavior,
that humans have to be very protective of what they have and be looking for there for number one.
I think that if we start from. As Adam Smith called it,
self-love or self-interest as a notion of must all of the time,
individuals will do what is good for them and their families and will engage their time, skills and resources
in pursuing their own goals. The question becomes
what system, what type of rules or structure will make that
pursuit not incompatible with some sense of fairness, general
well-being and praiseworthy naval neighborly
behavior? All right. So some some systems
channel that pursuit of self-interest in in ways that they are destructive
and damaging for orders. And for this society as a whole, it collapse.
We’ve seen those societies collapse through history. And sometimes the system
may control that pursuit or informed that pursuit in ways that may be beneficial
for. That’s Adam Smith. Miss often misunderstood the invisible hand. Right.
Like. Like. So the pursuit of drone benefit in
a system of voluntary free exchange makes you worry about what others want.
Right. And makes you think about how you could provide the things
that Orta wants any the process benefit yourself by making again better products, value creation.
But the problem may be that in that system you could have also those forces that make
you make auto routes or order processes attractive, such as like
gaining unfair advantages over orders just by virtue of lobbying or even
bribing because it does sort of thing. Right. Loving is is legal. These are legal means. Right. So asking
a CEO not to engage in this, he’s asking her to leave money on the table. That’s the next
question was and I ask, is that do you see the role of individuals in trying to better behave?
And, you know, so so is it empowered a better a more moral CEO? The way to
stop a company from go seek those those those special privileges
from government? Well, of course, my moral seal always on
ethical behavior. It’s always a good thing. Norms
on culture that condemned these unfair and immoral
behavior. It’s always a good thing. But the problem is that if.
It does where we start. It’s almost like assuming the problem away, right, legs like thinking
like what is a problem with corruption, that individuals engage in dishonest acts.
And then we say, well, right, we will have honest people, then we will solve the problem. Well, sure.
I’m sure we would like that. That’s precisely the issue. The question is,
why would an otherwise honest person will choose to engage in a corrupt
act or an immoral act? But but I guess it is. Is somebody
do we see as immoral acts or corrupt acts? Right. So I. When Mark Zuckerberg goes
on TV this week and says that. Absolutely. I see an enormous role for government
to play in regulating the social media platform space. Is he being corrupt, is
he trying to to to to protect what he has already built? Does he see directly that the direct
connection between saying while expanding the government role is going to just solidify Facebook’s position
in this market or it’s really, you know, an attempt to say, listen, there are problems with the
way the market of social media has has has grown. And I think we have a role
in through our government. And I even believe that governments can actually help in moderate and control.
The potential externality is being created by a social media platform. I’m not gonna question
his morality. So so I think that as long as people see that engagement as legal,
well, it’s acceptable. I guess that’s maybe that’s the norm that that I’m petition the government
for a good reason to do things here. Right. It can be both. Right. It can be the one that that
socotra or autres realize how advantages would be to get more protection in the landscape
because they are big enough to actually comply with the new rules. And the small players are not going to be able to do
that because they don’t have the leverage that Facebook does have. And the other thing
could be also like a well-informed worried about
the state of things and solving them. The order part here is that
I’m not sure if the larger audience, the consumers are fully aware of these dynamics.
I’m not sure. Mike Munger gave recently an interview at EconTalk with Ross
Roberts, and they were talking a lot about norms on culture and how principled consumers will actually
reject this type of behavior by not buying crony
ist products, quote unquote. Right to head of Cronus label on a product like we have the fair trade label
on a, you know, Buck Bekker coffee. So maybe you say, I don’t wanna buy the Krone coffee. Exactly. Exactly.
Right. Like now first, of course, you meet we need to talk
about how much incentives, how many incentives consumer has to be fully informed.
But but then is that information available? Do they realize when they hear agricultural
subsidies to protect farmers? Do they know that actually 80 percent
of the transfers go to the 10 largest corporations, corporations? Those are
not small farmers. Do they know maybe the average voter doesn’t know and she doesn’t
even want to know because maybe the impact on the prices are
relatively small for her. But for these corporations, this is big money.
So did you have also that dynamic? So I don’t want to say that morality doesn’t matter. I’m just saying that
as a starting point may be problematic. Now, of course,
if we started with rules that constrain these type of behavior, then you have another problem, which is why
would someone that is benefiting from the start of school change it?
Right. What would make a politician to say no? You know what? Granting these
special privileges capabilities is wrong. So we need to give them up.
Oh, wow. That we haven’t seen that happen in quite a while. I put political actors willingly giving
up. Our is not something that we see in history very, very well. I would say very that’s that’s a problematic
proposition. Yes. Right. So more concrete steps of thinking
about like thinking about, you know, having them defy this tendency, empowering consumers,
you mentioned as a potential route to try to understand this problem a little bit with consumers, understand this problem a little better.
They see that some companies are perhaps less and
less six less women trying to save one, try and say that they’re
they’re successful, but they’re not doing necessarily too their own act act effort, but perhaps by
by favors they extract from the government. If they see that kind of labeling, they see that information out there,
perhaps consumers as a way start acting a way that would alleviate this problem.
That’s a long term project. In order for it to get something like that, you know, it to be understood
and consume in a good way. Are there any other things that you can see or
in a political landscape that we live in right now that you think you think could be potentially beneficial
and to reduce this trend? And we are not very good at pointing out solutions in the paper,
as you know. Right. We just are good at a point.
Now, the problem like it’s a good start. Why was just. Sure. Sure. Sure.
Principal CEOs are always welcome, empowering CEOs to actually
be mindful about the nature of their entrepreneurship, entrepreneurial process and the value
creation and how that is the right way to advance their own interests in society and
so on. And avoiding them becoming rent seekers.
And on one hand, on the other hand, constraining state and state actors and in our ability to. Sell
a special privilege is actually the way to solve that, the problem is that
you’re asking these people to leave money on the table. Right. And all you need. Let’s suppose that you
have a CEO that says, I wouldn’t do this right. And then goes, Mike has this example
that goes to the stockholders meeting and said, like, guys, profits are down. But guess what? We’re
not taking a special privileges. We’re not we’re not engaging in lobbying. Probably like
the stockholder will say, what is going on here. And then it’s legal. We should do
it and do find somebody else, somebody else to do it. Right. And same for politicians.
Now, the big question that you ask. It’s a question of institutional change. And in my view, there is
structural institutional change has not that many sources. A crisis is one, a violent
struggle. These are not a one, a charismatic four year politically
that leads to a meaningful change. A lot of choices. Yeah, of course. But the problem with those three is that
you don’t know yet. The problem with those three is that you know which way they’re going to go. They can go one way or they can go down another way.
This low roude is changing ideas. And for those in academia like
ourselves, I engage in that world. We think that is in slow process, but is probably
the way. To make a sustainable change, so I will. I
think I think. I don’t know. I mean, I think that empowering consumers to be aware of this will be one way, one way
and the work of other institutions. Like think tanks
and advocacy groups that point out at this process as being morally wrong and economically wasteful.
Both things. Is is is
part of the solution. It’s not gonna be easy, but we need to do something because
again. The free market system is by far the best bet we have
at creating a more peaceful and prosperous society. So we need to protect it.
Absolutely. And again, writings like this and conversation like ours and the work we do. Right, is trying
to to always highlight those issues. And I feel that that we have had a a year of conversations in our
center where we hosted a lot of people that do work on in this area, in
the area of like somehow incumbency. I call it I’d like to use the word incumbency to talk about lots of different industries
or sectors where the incumbents have an enormous amount of advantage and they just slow
the ability for you to innovate. They just make things more expensive, less efficient and so on.
And I’m trying to remember some examples of conversations we had in finance
is a great example, right? Where, of course, where there’s a huge, huge sector of
our economy that perhaps is overly protected by the government. Not perhaps it is. And
following up on your point, after a crisis, what do we see? Extra protection for the big players. Right. So
so it’s a it can go really, really eat it away. And I think highlighting
those things, trying to educate the folks around us about those things is is all we can do. And to hope to to
really protect both those systems, not only the capitalist system to free markets, but I think the the the the
constitutional republic that we have, which is a model and a successful model for
most, most countries out there. And but, you know, it needs to continuously BBB between
with and protected better than the alternatives, I think. Exactly. Well, thank you so much for being for joining
us. A policy McKinzie for being part of CPA. And I look forward to the Mexican emmick. Here we are. This is the last one
in the 2018, 2019 year. We’re going to have a big summer ahead of us,
a blend in and growth. And I’ll see you back here in the fall, of course.
For all the people listening, stay tuned. And thanks for joining us. Thank you.
Before we wrap up, you can get more information in our medium page. Thanks for listening to
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