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By R.M.B Senanayake
‘When you leave the honey jar open, expect ants."—anonymous
WHAT IS CRONYISM and Crony Capitalism
I read the paper on Cronyism by David Henderson of the George Mason University, from which I have drawn the analysis below.
What is the difference between free markets and cronyism? In free markets, buyers and sellers are free to agree on price; no government agency restricts who can buy or sell, and no one is told how or what to produce. In contrast, under cronyism the government rigs the market for the benefit of government officials’ and their cronies. This takes various forms.
Cronies drove the stock market to a bubble
The stock market is being closely scrutinized by the powers that be. One set of brokers whose clients are powerful cronies of the big wigs are holding large portfolios of shares whose values have fallen on the average by 40% at least. Part of their money must be borrowed from the banks. They have the vain hope that somehow they can push up the market and unload their shares. They need to create a bull market to do so and they are banking on free credit to induce retail investors to enter the market. They are asking the regulators for more lax credit rules. But would any investor buy on credit when the returns in the market are negative?
Those brokers that didn’t charge interest but provided free credit to the investors now carry a large amount of bad debts in their books. They don’t want the authorities to set off the fall in value of the collateral portfolios in calculating the minimum net capital which all firms must maintain. If they fail to maintain the minimum they are liable to be suspended. So they keep pressing for higher credit limits and argue that the bad debts are part of their credit portfolio. But even if the authorities allow them to provide free credit, they won’t be able to create a bull market.
The economy is heading for lower growth given the high electricity prices and oil prices, rupee depreciation and credit restrictions. Those companies that took foreign loans are in trouble with the depreciation of the rupee by nearly 20%. All companies were earlier basking in a false economic atmosphere.
The EPF investments
It is right for the Employees Provident Fund to invest in the stock market? They like other investors will carry unrealized losses on their portfolios. They have to wait for the market to turn. The EPF is a fund and critics point out that fund managers do not seek to interfere in the management of the companies they invest in. They say the EPF has done so by using the voting power of its shares in the banks to get appointments to the boards of these banks. The directors so appointed represent nobody but those who got them the appointments. Behind them could be the shadow directors who could bring undue influence to bear on the lending practices of these banks. This would then constitute government interference in the management of the banks. This is a characteristic not of a market economy but of a crony capitalist economy like China and Russia.
Governments may also grant monopolies to one firm or limit the number of firms that can compete. For example, the Ceylon Electricity Board is a fully fledged monopoly and the Ceylon Petroleum Corporation does not face competition since the government will not allow the competitor, the Lanka Indian Oil Corporation, to determine its prices. So the petroleum prices are subsidized and there are no new entrants to the industry. Through corruption or inefficiency the CPC is importing tainted petroleum products. The government may also use quotas and tariffs ostensibly to protect domestic production but really to protect a loss making state sponsored enterprise. The government does not allow an independent regulator to determine the bus fares of the private bus operators.
Laws applied differentially have adverse economic effects
Good law should treat people in similar situations similarly. By definition cronyism treats people in similar situations differently. This particular individual gets a subsidy because of his connection to this minister; that one does not. This particular industry gets subsidies or government protection from competition because it is particularly effective at organizing political support; that industry, whose members are more into product innovation and less into lobbying, does not. In short, cronyism plays favorites. Mihin Air is given subsidized fuel to enable it to make profits. But it still makes losses. What is economically wrong with such favoritism to particular businessmen?
Economists refer to what they call zero sum games where one person’s gain is another person’s loss and there is no overall gain. Is cronyism a zero sum game where one person’s gain is balanced by another’s loss? No, it is not so. Cronyism is a negative sum game - in the process of redistributing wealth, cronyism destroys wealth. Sometimes it destroys large amounts of wealth in the process of giving relatively small amounts of wealth to chosen parties; Mihin Air is a good example. It doesn’t create wealth but destroys wealth - the capital of the country. It is the same with all other State Corporations which are really destroying wealth not creating wealth. This is distinct from free markets. In every free-market transaction, both buyer and seller gain or they would not engage in the transaction. Free exchange benefits both parties- the seller and the buyer, a point often missed by critics of Capitalism.
Suppose there is a local manufacturer of biscuits and his cost is Rs 90 and his selling price Rs 100 and he makes a profit of Rs 10. Suppose a foreign manufacturer can make the same good for Rs 70 and with a 10% profit he can export it to us at Rs 77. The gain to the consumer is Rs 23. Now the domestic manufacturer lobbies the government and asks the government to impose a duty of Rs 23. So now the price of the imported product increases to Rs 100.
But consider the gains and losses. At Rs 100, the local manufacturer gains Rs 10 per pack. The gain to local manufacturer from this tariff is thus Rs 10 per pack, but the loss to local consumer is not Rs 10 per pack. The local consumers are prevented from buying imports at Rs 77 and must now pay Rs 100. Their loss is Rs 23 per pack. The net loss in wealth to the local economy is Rs 13 per pack:
Cronyism also destroys wealth by shifting the allocation of resources away from what consumers want and toward what governments wants. Consider a simple case of a company producing a product consumers are buying. If consumers decide to buy less of that product, the decrease in demand will cause the highest-cost firms to go out of business or at least to shrink. As a result, resources would leave that activity and go to where consumers value them more. Now imagine that the government wants to "save jobs" and shore up profitability in the otherwise shrinking industry. It can do that by subsidizing the firms so they do not have to go out of business or shrink as much as they would otherwise have. Such subsidies are a typical example of cronyism. This is what happens when the government keeps propping up loss making State Corporations which have the freedom to function freely but are unable to make profits as is the case of Mihin Air.
By keeping resources in that use - in which consumers have clearly indicated their declining interest - the government prevents them from going to other uses consumers prefer. This is inefficient. It causes companies to produce more things the government wants and fewer things consumers want. The government thus distorts the economy. This is particularly evident in the postwar strengthening of the armed forces. They absorb part of the labor force which otherwise could have produced more goods desired by consumers instead of those purposes desired by the government.
Yet another way to see the destruction of wealth caused by cronyism is to note that government officials who direct resources have neither the right incentives nor adequate information to make good decisions. The incentive part is fairly obvious: Government officials are spending other people’s money, and no one is as careful with other people’s money as with his own. Hayek noted that the information a central planner would need to plan an economy well is information the planner cannot have because the relevant information exists in dispersed form in the minds of millions of people.
Private firms survey the market before investing. That insight should apply also to the government official trying to make investments of taxpayers’ money. That official cannot have the information he needs to make good investments. Our ministers don’t even care to carry out cost/benefit analysis before embarking on large investments on borrowed money. So large amounts of public money are spent which benefit crony capitalists in the first instance while the benefits to the people will lie in the future. It is doubtful if the future government budgets will even be able to maintain these infrastructure projects till they produce benefits to the people.
http://www.island.lk/index.php?page_cat=article-details&page=article-details&code_title=58436
By R.M.B Senanayake
‘When you leave the honey jar open, expect ants."—anonymous
WHAT IS CRONYISM and Crony Capitalism
I read the paper on Cronyism by David Henderson of the George Mason University, from which I have drawn the analysis below.
What is the difference between free markets and cronyism? In free markets, buyers and sellers are free to agree on price; no government agency restricts who can buy or sell, and no one is told how or what to produce. In contrast, under cronyism the government rigs the market for the benefit of government officials’ and their cronies. This takes various forms.
Cronies drove the stock market to a bubble
The stock market is being closely scrutinized by the powers that be. One set of brokers whose clients are powerful cronies of the big wigs are holding large portfolios of shares whose values have fallen on the average by 40% at least. Part of their money must be borrowed from the banks. They have the vain hope that somehow they can push up the market and unload their shares. They need to create a bull market to do so and they are banking on free credit to induce retail investors to enter the market. They are asking the regulators for more lax credit rules. But would any investor buy on credit when the returns in the market are negative?
Those brokers that didn’t charge interest but provided free credit to the investors now carry a large amount of bad debts in their books. They don’t want the authorities to set off the fall in value of the collateral portfolios in calculating the minimum net capital which all firms must maintain. If they fail to maintain the minimum they are liable to be suspended. So they keep pressing for higher credit limits and argue that the bad debts are part of their credit portfolio. But even if the authorities allow them to provide free credit, they won’t be able to create a bull market.
The economy is heading for lower growth given the high electricity prices and oil prices, rupee depreciation and credit restrictions. Those companies that took foreign loans are in trouble with the depreciation of the rupee by nearly 20%. All companies were earlier basking in a false economic atmosphere.
The EPF investments
It is right for the Employees Provident Fund to invest in the stock market? They like other investors will carry unrealized losses on their portfolios. They have to wait for the market to turn. The EPF is a fund and critics point out that fund managers do not seek to interfere in the management of the companies they invest in. They say the EPF has done so by using the voting power of its shares in the banks to get appointments to the boards of these banks. The directors so appointed represent nobody but those who got them the appointments. Behind them could be the shadow directors who could bring undue influence to bear on the lending practices of these banks. This would then constitute government interference in the management of the banks. This is a characteristic not of a market economy but of a crony capitalist economy like China and Russia.
Governments may also grant monopolies to one firm or limit the number of firms that can compete. For example, the Ceylon Electricity Board is a fully fledged monopoly and the Ceylon Petroleum Corporation does not face competition since the government will not allow the competitor, the Lanka Indian Oil Corporation, to determine its prices. So the petroleum prices are subsidized and there are no new entrants to the industry. Through corruption or inefficiency the CPC is importing tainted petroleum products. The government may also use quotas and tariffs ostensibly to protect domestic production but really to protect a loss making state sponsored enterprise. The government does not allow an independent regulator to determine the bus fares of the private bus operators.
Laws applied differentially have adverse economic effects
Good law should treat people in similar situations similarly. By definition cronyism treats people in similar situations differently. This particular individual gets a subsidy because of his connection to this minister; that one does not. This particular industry gets subsidies or government protection from competition because it is particularly effective at organizing political support; that industry, whose members are more into product innovation and less into lobbying, does not. In short, cronyism plays favorites. Mihin Air is given subsidized fuel to enable it to make profits. But it still makes losses. What is economically wrong with such favoritism to particular businessmen?
Economists refer to what they call zero sum games where one person’s gain is another person’s loss and there is no overall gain. Is cronyism a zero sum game where one person’s gain is balanced by another’s loss? No, it is not so. Cronyism is a negative sum game - in the process of redistributing wealth, cronyism destroys wealth. Sometimes it destroys large amounts of wealth in the process of giving relatively small amounts of wealth to chosen parties; Mihin Air is a good example. It doesn’t create wealth but destroys wealth - the capital of the country. It is the same with all other State Corporations which are really destroying wealth not creating wealth. This is distinct from free markets. In every free-market transaction, both buyer and seller gain or they would not engage in the transaction. Free exchange benefits both parties- the seller and the buyer, a point often missed by critics of Capitalism.
Suppose there is a local manufacturer of biscuits and his cost is Rs 90 and his selling price Rs 100 and he makes a profit of Rs 10. Suppose a foreign manufacturer can make the same good for Rs 70 and with a 10% profit he can export it to us at Rs 77. The gain to the consumer is Rs 23. Now the domestic manufacturer lobbies the government and asks the government to impose a duty of Rs 23. So now the price of the imported product increases to Rs 100.
But consider the gains and losses. At Rs 100, the local manufacturer gains Rs 10 per pack. The gain to local manufacturer from this tariff is thus Rs 10 per pack, but the loss to local consumer is not Rs 10 per pack. The local consumers are prevented from buying imports at Rs 77 and must now pay Rs 100. Their loss is Rs 23 per pack. The net loss in wealth to the local economy is Rs 13 per pack:
Cronyism also destroys wealth by shifting the allocation of resources away from what consumers want and toward what governments wants. Consider a simple case of a company producing a product consumers are buying. If consumers decide to buy less of that product, the decrease in demand will cause the highest-cost firms to go out of business or at least to shrink. As a result, resources would leave that activity and go to where consumers value them more. Now imagine that the government wants to "save jobs" and shore up profitability in the otherwise shrinking industry. It can do that by subsidizing the firms so they do not have to go out of business or shrink as much as they would otherwise have. Such subsidies are a typical example of cronyism. This is what happens when the government keeps propping up loss making State Corporations which have the freedom to function freely but are unable to make profits as is the case of Mihin Air.
By keeping resources in that use - in which consumers have clearly indicated their declining interest - the government prevents them from going to other uses consumers prefer. This is inefficient. It causes companies to produce more things the government wants and fewer things consumers want. The government thus distorts the economy. This is particularly evident in the postwar strengthening of the armed forces. They absorb part of the labor force which otherwise could have produced more goods desired by consumers instead of those purposes desired by the government.
Yet another way to see the destruction of wealth caused by cronyism is to note that government officials who direct resources have neither the right incentives nor adequate information to make good decisions. The incentive part is fairly obvious: Government officials are spending other people’s money, and no one is as careful with other people’s money as with his own. Hayek noted that the information a central planner would need to plan an economy well is information the planner cannot have because the relevant information exists in dispersed form in the minds of millions of people.
Private firms survey the market before investing. That insight should apply also to the government official trying to make investments of taxpayers’ money. That official cannot have the information he needs to make good investments. Our ministers don’t even care to carry out cost/benefit analysis before embarking on large investments on borrowed money. So large amounts of public money are spent which benefit crony capitalists in the first instance while the benefits to the people will lie in the future. It is doubtful if the future government budgets will even be able to maintain these infrastructure projects till they produce benefits to the people.
http://www.island.lk/index.php?page_cat=article-details&page=article-details&code_title=58436
