Chicago Booth: "How Market Power Leads to Corporate Political Influence"

From the ProMarket blog at the Booth School of Business, University of Chicago, July 12, 2017:

Neoclassical economic theory assumes that firms have no power to influence the rules of the game. A new paper by Luigi Zingales argues: This is true only in competitive product markets. When firms have market power, they will seek and obtain political influence and vice versa.

In 2016, the advocacy group Global Justice Now published a report showing that 69 of the world’s largest 100 economic entities are now corporations, not governments. With annual revenues of $485.9 billion, Walmart topped all but nine countries. As the world’s corporations continue to grow bigger and more profitable, so does the power and influence they wield: multinational corporations employ vast armies of lobbyists, lawyers, and PR people across borders and continents, and they have more than enough resources to capture regulators and elected representatives the world over.

Yet, the prevailing economic definition views firms as merely “a nexus of contracts” with “no power of fiat, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting between two people.” How is it possible to reconcile these two views? A new paper by Luigi Zingales (Faculty Director of the Stigler Center and one of the editors of this blog) tries to bridge this gap.

The Medici vicious circle

The neoclassical model of the firm, notes Zingales, is a reasonable description of firms operating in highly competitive markets, where firms have little incentives and fewer resources to distort the rules of the game. Little incentives because in a neoclassical framework firms are relatively small, and thus the costs of these activities tend to exceed their share of the benefits. Fewer resources, because a competitive market does not provide firms with abnormal profits to spend in lobbying activities. 

The opposite is true in concentrated markets, where firms enjoy sufficiently high profits to spend in lobbying activity. Some market power is particularly important to gain political influence when cash bribes are relatively rare, writes Zingales. In such an environment, firms gain political power through promises of future benefits. Only if firms have significant market power do they have rents to allocate. At the same time, firms’ promises of future rents are credible only to the extent that firms are expected to be around in the future, a prospect greatly enhanced by the existence of some barrier to entry in the markets in which they operate. Thus, firms can gain political power only when they have significant market power.

If market power is needed to acquire political influence, political influence is needed to protect market power. In fact, whenever prices are greater than marginal cost, the government can intervene to appropriate part of the difference, without affecting the quantity of goods produced.  Consistently, writes Zingales, governments tend to expropriate firms only when they enjoy rents due to the ownership of scarce natural resources (e.g., oil) or natural monopolies (as the postal service was historically). In democratic regimes there is a political justification to expropriate monopolistic firms: the government can claim that it does so to redress market distortions. Thus, firms with market power fear expropriation the most, and therefore they will try to control the government as a preemptive move, to avoid ending up being owned by the government.

In sum, market concentration can easily lead to what Zingales refers to as the “Medici vicious circle.” Named after the banking family that ruled Florence throughout the Italian Renaissance, the Medici vicious circle can be summed up as: “money is used to gain political power and political power is then used to make more money.”  

A balance between state and private power

Is it necessarily bad for firms to have political power? The more a state is predatory, the more firms need political influence to prevent political expropriation, contends Zingales. But the more political influence firms have, the more the state will meddle with the economy, transforming itself from an impartial arbiter to an arbitrary dictator. ...MORE