Crony Capitalism

 

Increasingly these days, one reads or hears about how the capitalistic system is failing, dying or totally unjust. These are not new comments but, with the rise of social media, they are becoming louder.

 

Clearly, I do not embrace such thinking. The fault to me lies not in the capitalistic (free market) model but rather with the growing scourge of Crony Capitalism.

 

Let us define the term. Crony Capitalism is hardly a new phenomenon in the contemporary world but it occurs when there are very close ties between leading business people and politicians. The political class does favors for their friends in business via special tax breaks, government grants, and eliminating regulations that stifle their activities of their pals in specific fields. Many critics single out the United States these days as large political contributors appear to get special consideration from members of both major political parties. This tends to lead to more income inequality over time.

 

Now, over the years, I have mentioned in MR that any country that has a semblance of a free-market orientation will have evidence of income equality. Some people work harder, others are cleverer than most of us, some are in the right place at the right time, and yes, some are just plain lucky.

 

Yet, things seem to be getting more extreme. A few years ago, it was noted that the three wealthiest Americans has a net worth equal to the bottom 50% of the population.

 

This skew to a few appears to cause more than simple jealousy and envy. Canadian economist Miles Corak has done detailed work illustrating how as income inequality increases in a nation, upward mobility decreases. This idea gets a good bit of traction when polling indicates that many young adults do not see themselves ever living as well as their parents.

 

Others sarcastically call the current wealth skew “The Great Gatsby Curve”, an illusion to F. Scott Fitzgerald’s 1920’s novel about the elegant lifestyle of Jay Gatsby and his acquaintances.

 

Some examples of Crony Capitalism are:

 

1)  Inversions—large American companies with a high volume of international sales change their headquarters to a foreign jurisdiction with much lower taxes. Or, they run a subsidiary in the tax friendly location and attribute U.S. sales to that subsidiary. Their taxes due to the IRS plummet. Legal, yes but ethical, highly unlikely. International legislation is pending to combat this.

2)  The Carried Interest Trade—this one really gets my blood boiling. Carried Interest is “a share of profits earned by general partners of private equity, venture capital and hedge funds.” This is especially beneficial to hedge funds as their normal fees are baked into carried interest so they may pay only 20% tax vs. the 37% that we poor normal slobs pay for our income. Warren Buffett and hedge fund chief Bill Ackman have been strong supporters of ending this loophole. Buffett has claimed that a fund can hold shares for only a minute and the tax is only 20%. You or I would pay a much higher rate for such a short-term trade. It strikes many as ridiculously unfair and only applies to a tiny group of people among the 330 million Americans. In the recent “Inflation Reduction Act”, an early draft had the elimination of the carried interest loophole baked into the cake. Krysten Sinema, an Arizona Democrat, would only support the bill if the Carried Interest provision was left intact.  Her vote insured the passage of the bill. It turns out that she has received substantial donations from investment banks and hedge funds.

3)  Too Big to Fail—we heard a good bit about this after the 2008 financial debacle. It happens when government funds are used to socialize losses without any cost to those who caused the losses. In other words, management or their traders made very risky bets and got rewarded when they succeeded but were bailed out by hapless taxpayers when they failed. Some brass lost their jobs but no one went to prison.

 

There are many other examples including barriers to entry which government enacts to protect friendly entrenched players, government grants to key companies, coercive monopolies where anti-competitive measures are passed  by legislatures, and a blind eye that ignores existing regulations that applies to companies with solid political contacts.

 

The role of government in a free-market economy has long been said to get out of the way of business. Okay, but what about rule #2 which is to enforce the rules of the game and try for a level playing field that encourages competition?

 

Capitalism is not a perfect system but it is not nearly as flawed as its critics say. If it goes down in parts of the western world at some point in the future, to me it will be because Crony Capitalism not authentic Capitalism has ruined it.

 

You may reach Don Cole at doncolemedia@gmail.com or leave a comment on the blog.