Saturday, April 21, 2018

Is the System Rigged? Adam Smith on Crony Capitalism, Its Causes—and Cures

Following up on last week's "OUP's Philosopher of the month: Adam Smith".
More than just another pretty face pin factory.
From the Heritage Foundation, March 31, 2018:
For Adam Smith, crony capitalism fails on two grounds: It is unjust, favoring a few at the expense of the many, and it is destructive of the desired end of political economy—economic growth. Smith’s writings are of great use today in their capacity to properly frame this problem, its causes, as well as solutions for preventing or mitigating the corruption of free markets. For Smith, the tendencies to cronyism, which are anchored in human nature, can be tempered by: (1) limiting government to a few essential powers (defense, administration of impartial justice, and certain limited public works and institutions); and (2) educating the public concerning the “folly” of attempts to direct the economy by legislators. These approaches offer the best chance to limit crony capitalism, its corruption of natural liberty, and its consequent undermining of benefits of free markets.

Adam Smith, the intellectual founder of modern free-market economics, famously called the economic system he advocated “the obvious and simple system of natural liberty.” The benefits he claimed for this system of natural liberty include the wealth of nations and an increase in the independence, liberty, and security of all members of society—but especially of the non-elite members.
He particularly defended it on the grounds that robust economic growth offered the best opportunities for the less advantaged members of society:
The liberal reward of labor, therefore, as it is the necessary effect, so it is the natural symptom of increasing national wealth. The scanty maintenance of the labouring poor, on the other hand, is the natural symptom that things are at a stand, and their starving condition that they are going fast backward.
 Comparing our present situation to conditions when he wrote, we are compelled to admit that these benefits have been substantially realized by the system we now call free markets or capitalism.
Yet despite this almost unbelievable acceleration of wealth and liberty in the countries that have adopted Smith’s system, few would claim that this progress has been simple or uncontroversial—or that the benefits have accrued equally to all. Noted libertarian Charles Koch, writing in the Washington Post, argued that he agreed with one claim made by socialist Senator Bernie Sanders: that the system is rigged in favor of the few.

Is there something inherent in the system of natural liberty, or in human nature itself, that is systematically corrupting in ways that undermine its claims of universal benefits? Is Smith overly optimistic or naïve in his claims concerning the benefits of free markets?
...Smith warned that natural liberty faces natural obstacles in the form of human nature, particularly the desire of especially “merchants and manufacturers” to “rig the system.” They accomplish this self-enriching corruption of free markets by using the power of government to procure for themselves “systems either of preference or of restraint.” In so doing, they impose an “absurd tax on the rest of their fellow-citizens.” These preferences and restraints are what we today call crony capitalism....
...MUCH MORE (17 page PDF)

Two quick points:
1) The Heritage Foundation received some of their past funding from entities associated with the Koch brothers. I don't know if they still do.

2) Very oddly, the author does not  explore (or even mention) Smith's often quoted, sometimes misunderstood comment:
"People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices." 
The Wealth of Nations, Book I, Chapter X.
It's a natural jumping off point to get to Smith's greater concern. that bad as business collusion can be, collusion between business and government is much worse.  However in a footnote referencing our old pal William Baumol we do see:
“Most people think of entrepreneurship as being the ‘productive’ kind, as Baumol referred to it, where the companies that founders launch commercialize something new or better, benefiting society and themselves in the process.

A sizable body of research establishes that these ‘Schumpeterian’ entrepreneurs, those that are ‘creatively destroying’ the old in favor of the new, are critical for breakthrough innovations and rapid advances in productivity and standards of living. [Note: The research in question can be found at David Audretsch, “Entrepreneurship: A Survey of the Literature,” European Commission Enterprise Paper No. 14 (2003), Survey_of_the_Literature (accessed March 15, 2018).]

Baumol was worried, however, by a very different sort of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to construct regulatory moats, secure public spending for their own benefit, or bend specific rules to their will, in the process stifling competition to create advantage for their firms. Economists call this “ rent-seeking behavior .” Robert E. Litan and Ian Hathaway, “Is America Encouraging the Wrong Kind of Entrepreneurship?” Harvard Business Review , June 13, 2017, http://www. (accessed March 15, 2018)
See "Some Stories About William Baumol" and more pertinently: "The Dangerous Rise Of Unproductive Entrepreneurship" and Frank Pasquale: "Entrepreneurship Can Be Unproductive or Destructive".

Additionally, here's Baumol's 1990 paper "Entrepreneurship: Productive, Unproductive, and Destructive". (30 page PDF)