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Cronyism: Undermining Economic Freedom and Prosperity Around the World James M No. 2447 August 9, 2010 Cronyism: Undermining Economic Freedom and Prosperity Around the World James M. Roberts Abstract: Backroom deals between members of the gov- erning class and their hand-picked cronies influence the legislative, executive, and regulatory actions of govern- Talking Points ments around the world. Examples of this ancient form of • Around the world, “crony capitalist” arrange- corruption abound. Government intrusions into the pri- ments increasingly influence the legislative, vate sector as a partner, financier, or outright owner are executive, and regulatory actions of govern- not only morally hazardous, but toxic to economic free- ments—in foreign countries as well as in the dom. Such special-interest arrangements directly contra- United States. dict the principles of freedom, incentives, and opportunity • Crony capitalism directly contradicts the detailed in The Heritage Foundation’s Index of Economic core principles of The Heritage Foundation’s Freedom. Citizens of any country need a system of non- Index of Economic Freedom: rewards for indi- discriminatory markets and impartial credit allocation, as vidual success, equitable treatment, and well as rewards for individual success, in order to get ahead open competition. based on merit and hard work. • Crony capitalism is frequently associated with the ascendance of statist policies. Gov- ernment intrusion into the private sector as a partner, financier, or outright owner is not only It is common these days for those who feel a symptom of morally hazardous crony capi- “exploited by the system” to lash out at capitalism as talism, but is also toxic to economic freedom. the cause of their economic woes. When their com- • The corrosive effect of crony capitalism on plaints are examined, however, what stands out is not the body politic looms as a major threat to anger at an actual free-market capitalist system, but democratic stability. frustration with the prospect of an almost insur- mountable economic system of privilege based on • Government leaders everywhere should reject cronyism, privatize the firms under state cronyism. In many parts of the globe, aspiring entre- control, and generally maintain arms-length preneurs, willing to work hard and full of ideas and and even-handed relationships with all firms. energy, start out against a stacked deck because they lack political or family connections. This paper, in its entirety, can be found at: To get ahead based on sheer merit and hard work, http://report.heritage.org/bg2447 Produced by the Center for International citizens of any country need a system that maintains Trade and Economics (CITE) non-discriminatory markets and impartial credit allo- Published by The Heritage Foundation cation, as well as rewards for individual success. That 214 Massachusetts Avenue, NE Washington, DC 20002–4999 (202) 546-4400 • heritage.org Nothing written here is to be construed as necessarily reflecting the views of The Heritage Foundation or as an attempt to aid or hinder the passage of any bill before Congress. No. 2447 August 9, 2010 is the recipe for economic freedom—and for the ing from cronyism might fairly be described as opportunity to escape poverty and build lasting socialist, fascist, or communist. All three substitute prosperity. Yet in far too many cases the future Sam government decision making for the collective Waltons, Ray Krocs, and Bill Gateses of the world judgment of the marketplace in allocating resources are trapped in systems dominated by cronyism and for production and consumption. Any of these sys- corruption, where those with special access to gov- tems can work in theory, although socialism has ernment favors or information and those who enjoyed long-term success only in a few Western already enjoy monopoly power dictate pricing and European societies that are highly cohesive demo- conditions of service, often becoming extravagantly graphically and which enjoy high standards of ethi- rich in the process, while denying millions of their cal behavior: Their citizens traditionally have countrymen that very same access. trusted each other and their governments to “do the In a true capitalist system success is determined right thing.” It is not socialism per se; to the extent by the market, the best mechanism ever discovered that European socialism has succeeded it is thanks to set the value of goods and services—through the to a system that might better be called “extended- collective buying and selling decisions of all partic- family capitalism.” ipants in the economy, not only through a select few “Vertical Collectivistism”: Less Economic with special access to government overseers or Freedom, Plenty of Corruption inside information. Before they were defeated by the economically The Blight of Crony Capitalism freer Allied Powers, two of the massive (and Every day around the world decisions are made deadly) 20th-century experiments in applied theo- by government leaders to insinuate themselves and retical socialism—fascism and communism—were their bureaucracies as a partner, financier, or out- held together in practice by what could be termed crony-capitalist-like arrangements. Fortunately the right owner of formerly private corporations and 1 enterprises, sometimes in joint ventures with labor “vertically collectivist” and totalitarian states unions. Often this insidious and growing “crony known as Nazi Germany and the Soviet Union capitalism” is linked with European corporatist- finally collapsed onto the ash heap of history, with style industrial policies, hailed by their statist sup- a big push from the West. They held together as porters as the “public–private” wave of the future. long as they did only by suppression of most Those who study history, however, already know human rights. Free-market capitalism, by contrast, the ending of this story, and it is not a happy one. has enjoyed long periods of success in a variety of social settings. When the collective decisions of the marketplace are overridden by government regulations, price The jury is still out on whether Chinese reform- ers will finally get the upper hand over China’s cro- setting, or even direct control or state ownership of 2 natural resources, then “the system” is something nyist nomenklatura and “princelings,” but many quite distinct from free-market capitalism and truly European welfare states that did not learn from their does become the enemy of the “little guy.” sorry history of cronyism (Greece, Spain, and Por- tugal, for instance) are already facing potential Depending on the type and extent of govern- bankruptcy. ment interference in the economy, the system result- 1. “Cronyism is most likely to occur in vertical collectivist cultures.” Naresh Khatri, Eric W. K. Tsang, and Thomas M. Begley, “Cronyism: A Cross-Cultural Analysis,” Journal of International Business Studies, No. 37 (January 1, 2006), pp. 61–75, at http://www.palgrave-journals.com/jibs/journal/v37/n1/full/8400171a.html (July 23, 2010). 2. For more about China’s “princelings,” see James M. Roberts, “Access to Information: Vital for Efficient Markets and Economic Reform,” in Terry Miller and Kim R. Holmes, 2010 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones & Company, Inc., 2010), pp. 43–55, at http://www.heritage.org/index/PDF/2010/Index2010_ Chapter4.pdf. page 2 No. 2447 August 9, 2010 From the failed and costly takeover of the Brit- yields and underwriting fees. Those higher bond ish automotive manufacturing sector by a socialist yields translate directly into higher taxes.3 government in the 1970s to the refusal today by • Examining cronyism and capital controls in the Chinese government to reform its sclerotic Malaysia, Simon Johnson and Todd Mitton state-owned enterprises, the record of statist poli- concluded that “cronyism increases with capital cies is generally one of commercial failure and a controls” and demonstrated that “only firms vastly expanded, empowered, and burdensomely previously connected to Prime Minister Mahathir expensive public sector staffed by too many med- experienced a disproportionate increase in stock dlesome bureaucrats. price in September 1998”4 in the aftermath of In economically free societies everyone benefits the Asian financial crisis. when honest and hard-working men and women, • In his study of corruption in South Korea relative who have confidence that they can retain the fruits to Taiwan and the Philippines, Jong-Sung You of their labors, have incentives to invest and work noted that the concentration of wealth created by harder. That confidence is destroyed when the eco- “chaebol industrialization increased corruption nomic system is controlled by a government that over time in Korea, in comparison with Tai- directs the largesse and power of the state to those wan.”5 You found that cronyist Korean chaebols, with connections. This sort of corruption is the def- the large, family-controlled, vertical monopolies inition of cronyism. established with the encouragement of South Cronyism, Corruption, and Diminished Eco- Korea’s dictator-president Park Chung Hee in the nomic Performance. Beyond the myriad anecdotal 1960s (and modeled on the pre-World War II stories available around the world, the correlation zaibatsu in Japan), intended to spur rapid indus- and causation between cronyism, corruption, and trialization, but devolved into economically (and reduced economic performance has been robustly politically) destructive cronyist arrangements. analyzed and established by a number
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