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Please Don’t Feed the Businesses

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Please Don’t Feed the Businesses

Ending crony capitalism requires understanding the difference between a pragmatic, pro-market dispensation and a dogmatically pro-business one. August 15, 2021
Economy, finance, and budgets

Let me start with a story. The first time I visited the Grand Canyon many years ago, I was struck not only by its natural beauty but also by a sign that said, “Please don’t feed the wild animals.” Underneath was an explanation: you shouldn’t feed them because it’s not good for them. It’s not that you’re trying to save them food; it’s just that if they get used to eating and gathering human food, then they lose their ability to live independently in the wilderness.

We should post something of this kind on Capitol Hill as well—with the difference being that the sign would read, “Please don’t feed the businesses.” That’s not because we don’t like business. Quite the opposite: we love business so much that we don’t want to create a situation where business is so dependent on a weak system, a system of subsidies, that it is unable to compete and succeed in the global marketplace.

In a competitive system, businesses make money because they are better. In a crony capitalist system, businesses make money because they have distorted the rules to their advantage or because they have found a way to divert money to their advantage.

This is the fundamental distinction, all too often unappreciated by the press and in political debate: the difference between being pro-market and being pro-business. If you are pro-business, you like subsidies for businesses; you want to make sure that they make the largest profits possible. If, on the other hand, you are pro-markets, you want to behave like the ranger in the Grand Canyon: by enacting restrictions, ensuring that markets remain competitive and rules are designed properly, and preventing businesses from becoming too dependent on a crony system to survive.

Why are we as economists so in love with competitive markets? Because we know that in general, competitive markets deliver good social outcomes. It’s important to appreciate, though, that these good outcomes do not always come naturally.

We use the term “free markets” so often that we sometimes forget what it actually means. If you look up “free markets” in the dictionary, you might see “an economy operating by free competition,” or better, “an economic market or system in which prices are based on competition among private businesses and not controlled by a government.” Both definitions emphasize the element of competition, which is important. But they don’t say—in any possible form or shape—that markets operate without rules. Because, in fact, markets do need rules to operate well and to be competitive.

There is a reason, however, that these rules might be distorted to create barriers to entry. For example, in Italy, I know that to write any insurance contract, you have to sign a document in person. Why? Simply because the incumbent insurance company is trying to block online insurance from competing, so they impose an undue burden on consumers to make sure that the competition is hampered. That’s the problem when rules get distorted in favor of incumbents.

Basically nothing guarantees that the process of rule formation will deliver decent, if not optimal, rules. Incumbents have many ways to shape rules in their favor; in general, we see very pronounced biases in their favor. The question that I tried to address in my co-authored 2003 book, and in research that I’ve done since, is this: how do we make sure that we have the rules to make the market competitive, but don’t have such an excessive amount of rules that they stifle competition and gains in efficiency?

How indeed. In a sense, the tension in a capitalist economy is that we want everything to be for sale, except the rules themselves. For if the rules were for sale, they would be bought out by probably the most powerful incumbent and would not be designed to keep the market open. So we would like the rules to be set by somebody like an independent arbiter. But as we know, these independent arbiters are hard to find.

To assure that the rulemaking process retains its independence, we can learn a lesson from Bitcoin. I’m not a particular fan of Bitcoin—I don’t think that it is going to be very successful long-term—but some of the ideas behind it are useful. One is that the best way to make a system robust to corruption is to decentralize and distribute the power. Similarly, the best way to make sure that rules are designed to make markets more competitive and not to favor incumbents is to try to bring to the table the largest number of people. If you have to legislate to make rules about general principles, it will be much easier to find some points in common that benefit everyone. Once we go into the details and bring the interested parties to the table, those parties will have a vested interest in distorting the rules to their advantage.

In practice, this decentralization, this distribution of power, is nothing less than a form of democracy. If you want a capitalist system to work well, you need to have a democratic system that works well at the same time. You need to bring to the democratic process as many people as possible because they are more likely to design rules in the interest of the community at large rather than the interests of a few small producers.

What can we do to bring more people to the rulemaking process? One idea explored by economist John Matsusaka is to use more direct democracy. Direct democracy has a bad reputation, at least recently. But we can’t choose an institutional system based on one observation. We need more evidence. In a recent book, Matsusaka looked at the evidence—for example in the United States, and especially western states like California with a long tradition of introducing popular initiatives and referenda—and found no evidence that referenda tend to favor incumbent businesses. In fact, the vast majority of referenda approved in the western United States from the beginning of the twentieth century until 2017 introduced some regulation to business that business did not necessarily like, but that the community at large preferred. Hence, direct democracy cut down on the intermediaries that typically exist in a delegated democracy—the first group that can be bought out, captured, or bribed by incumbent businesses. In this respect, the transparency of direct democracy represents a step in the right direction.

The second idea, which I discuss in my book, is to keep legislation and regulation as simple as possible. Glass-Steagall, the law enacted in the 1930s that separated commercial banking from investment banking, was so popular because it was so simple. Immediately after the financial crisis, lawmakers felt immense pressure to reintroduce some form of Glass-Steagall. The Obama administration, including then-Treasury secretary Timothy Geithner, decided to go with a different form of regulation, called the Volcker Rule. This was a cynical, Machiavellian act: I think Geithner knew perfectly well that the Volcker Rule was unimplementable, but he went for it because most of the public wanted the separation, while the banking industry didn’t. Geithner compromised by finding a rule that was named after a remarkable, highly respected person but was so complicated that it basically was unimplementable. That is the typical example of a bad rule because it’s so complex that people can manipulate it, and incumbents enjoy a huge advantage in that game.

The main reason to keep a rule simple is to make it difficult for lobbyists to sneak loopholes into the rulemaking process. I am an economist. I like to play the game of finding the most efficient solution to problems. In spite of this, I think we should have simple rules—even at the cost of some economic efficiency. In principle, one can enact more efficient rules. But the moment you tweak them and make them complicated, the opportunity for lobbyists to restore their advantages grows.

Simple rules are desirable for two more reasons. First, if you want the public to express its support for laws, the simpler they are, the easier it is to drum up the support. Second is that you can at least determine whether simple rules are being enforced or not.

For competitive markets to work well, we need some basic rules. Capitalism’s biggest challenge is to find a mechanism to put these rules in place without distorting the system. We’re still struggling with this. But I think that going in the direction of greater public involvement and simple rules might make the process easier and more successful.

Photo: hyejin kang/iStock

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