Is capitalism failing? In a speech last week at Policy Exchange Environment Secretary Michael Gove argued that capitalism is failing to deliver. He placed the blame on crony capitalism stating: “Economic power has been concentrated in the hands of a few and crony capitalists have rigged the system in their favour and against the rest of us”.
Gove isn’t the only thinker on the right to decry crony capitalism. In my view, it’s a part of an attempt to co-opt the left’s discontent with markets. This is unwise at a time when in many areas our economy is extremely liberal compared to most of history and the rest of the world.
Crony capitalism is a real problem. Misguided intervention in the market can entrench well-connected incumbents, stifle innovation, and increase inequality.
But I suspect too many are overrating the importance of crony capitalism because of its narrative appeal. Rather than a general system of cronyism, we have a capitalist system which mostly works but isn’t allowed to work in specific markets (e.g. housing).
There’s a general imprecision around the term. In Gove’s speech he mentioned the need to “look at the incentives which exist to reward rentiers and promote schemes like share buybacks, rather than encourage productive investment.” But share buybacks don’t detract from productive investments. Rather they release cash from companies with few productive investment opportunities to shareholders who then give it to companies with more profitable projects to invest in.
Gove also brought up executive pay. He’s not the first. Theresa May described it as the “unacceptable face of capitalism”. But as University of Chicago economist Steven N. Kaplan argues “The reality of executive compensation reveals a far different picture from this caricature of skyrocketing pay packages and crony capitalism.” He and his colleague Joshua Rauh looked at 1,700 firms and found “that compensation was highly related to performance: The companies that paid their CEOs the most saw their stocks do the best, and those that paid the least saw their stocks do the worst.”
Part of the problem is that crony capitalism has become a catch-all term. It no longer focuses purely on cases where cronies have prospered by taking advantage of political connections. Attacks on crony capitalism too frequently devolve into attacks on capitalism.
In reality, the real ‘cronies’ are typically not CEOs. Rather they cut a sympathetic figure. It’s the NIMBY homeowner opposing new development because “it’s not affordable” and will “put pressure on local services” or the barrister that wants to protect the public from insufficiently trained solicitors.
In many cases, crony capitalist outcomes are the result of lobbying from consumer groups. Take OfGem’s Non-Discrimination Condition which banned energy companies from charging consumers less in one region and more in another. It resulted in less competition and higher margins.
It is easy to make the case against “fat cats” profiting off political connections, but it’s harder to target well-organised and often sympathetic interest groups. Yet all the evidence points to the latter causing the most harm. That’s especially true in the case of restrictions on building new homes, which Moretti and Hsieh estimate leads to a 13% reduction in GDP in the US.
In his speech Gove was right to link popular discontent and the shift to populism to falling productivity growth. But addressing sluggish wage growth will require tackling popular special interest groups, not just easy targets.