Crony Capitalism

What Makes a Billionaire Bad? Just Add Government.

Cronyism, not the free market, is what makes income inequality harmful.


You can't have a monopoly without the government regulating the competition away.

"Income inequality" is one of the populist issues du jour, even if there is a certain logical incoherence in believing that the growing income of rich people is somehow necessarily bad for poor people.

A new economic study suggests that, actually, we can calculate when a billionaire's riches harm the poor and when they're helpful. The "bad" billionaires aren't the ones who flood the marketplace with cheap goods and jobs that some folks want to blame for all our ills. Those billionaires help the poor (by providing cheap goods and jobs, obviously). It's the billionaires who get and keep their riches because of their connections to the government and through crony capitalism who create the most harmful consequences of income inequality. From the Washington Post:

Specifically, when billionaires get their wealth because of political connections, that wealth inequality tends to drag on the broader economy, the study finds. But when billionaires get their wealth through the market — through business activities that are not related to the government — it does not.

The idea is perfectly logical. Billionaires who get their wealth through the market have to provide a good or a service others find valuable and they have to do so efficiently and at a price their customers can afford. When the prices are low, the poor are able to get the goods that they need to thrive and still keep more of their own money. When the customer is the government those market efficiencies just often are not there or not as pronounced. Government is not spending its own money. It has much less of an incentive (if any) to be careful. It shrugs off cost overruns (or embraces them since government employees are often the beneficiaries), allowing crony billionaires to cash in by taking more of the money of the citizenry yet not having to care as much about efficiency or pricing as their market-oriented brethren. Thus, the economic multiplier is subverted. Citizens are forced to give money to the government, who gives it to cronies (and themselves), who then provide inefficient and costly goods and services that are actually worth less than what was paid for them.

The researchers for this study went global to try to quantify this logic. It would be tough to try to calculate this impact in America and other Western countries because there's a complicated mix of market and crony capitalism. In countries like Russia and India, it's a lot easier to observe:

The researchers used a very conservative standard for classifying people as politically connected, only assigning billionaires to this group when it was clear that their wealth was a product of government connections. Just benefiting from a government that was pro-business, like those in Singapore and Hong Kong, wasn't enough. Rather, the researchers were looking for a situation like Indonesia under Suharto, where political connections were usually needed to secure import licenses, or Russia in the mid-1990s, when some state employees made fortunes overnight as the state privatized assets.

Using such a calculation, the United States actually ranked surprisingly low. The researchers calculated that only one percent of America's Gross Domestic Product owned by billionaires is a direct result of political connections. Compare that to 84 percent of Colombia's GDP or 66 percent of India's GDP. That America's number is actually a lot lower than we might think could explain that, despite all the populist complaints about income inequality, our low-income citizens still have access to goods and services and parts of the marketplace that would have turned their great-grandparents green with envy. But in countries like Colombia and India:

When the researchers compared these figures to economic growth, the findings were clear: These politically connected billionaires weighed on economic growth. In fact, wealth inequality that came from political connections was responsible for nearly all the negative effect on economic growth that the researchers had observed from wealth inequality overall. Wealth inequality that wasn't due to political connections, income inequality and poverty all had little effect on growth.

"The negative effects of wealth inequality are largely being driven by politically connected wealth inequality. That seems to be the primary channel that drives this relationship," [researcher Sutirtha] Bagchi said in an interview.

And here is your libertarian, free market "OF COURSE, THIS IS WHAT HAPPENS" moment:

Politically connected business elites can charge consumers higher prices for services, control access to bank loans and other funding, and prevent outsiders from starting competing businesses. "One of the things that shocked us is that once the billionaires had a significant amount of wealth, they would often take steps to try to limit the amount of competition," Bagchi said.

I'm shocked that anybody who studies economics would be shocked by this.

Read more about the study and other examples here.

(Hat tip to Tom G. Palmer of the Cato Institute and Atlas Network)