You Can't Regulate Crony Capitalism Away

Increasing the scope of government over business accelerates the problem of crony capitalism.

In a time of political polarization, it can be reassuring when the left and the right agree on an issue. One such area of consensus is the recognition of crony capitalism, where big business and government work together for their own interests through systems of reciprocal favors.

The Taxi Industry Is a Prime Example of Crony Capitalism

An example of crony capitalism can be seen in the conflict between rideshare companies, like Uber and Lyft, and the taxi industry. Because Uber poses a competitive threat to the taxi business, the taxi industry has pushed hard to ban Uber from cities across the country by lobbying local governments with varying degrees of success.

The taxi industry has enjoyed a monopoly for a long time thanks to their close relationship with government. By creating occupational licenses and charging what is often several hundred thousand dollars for a medallion, the taxi industry posed massive barriers to entry on their competition. Now, this government-sanctioned monopoly is facing an inevitable dissolution because of the innovation of ridesharing companies.

Although both sides of the political spectrum may agree that relationships like the one between the taxi industry and local governments are a problem, they often disagree on the solution.

Increasing the scope of government over business accelerates the problem of crony capitalism. The Solution of Increased Regulation Is No Solution at All

The solution usually proposed by the left is to give the government more power to regulate business. The theory is that if we can increase the scope of the government, then government can clamp down on big business. But although this may sound good initially, it ignores the incentives created by government regulations.

When government has more power to regulate business, businesses will respond by shifting more of their resources towards influencing the government to intervene in their favor. Businesses are incentivized to twist the law to their own advantage. Put simply, when government has the power to control businesses, businesses will end up controlling the government.

Increasing the scope of government over business accelerates the problem of crony capitalism in a cyclical manner that resembles a positive feedback loop. The government is given more power to regulate business, so businesses shift more resources towards gaining advantages using government power, and on and on it goes. Although many people who want the government to regulate business may have good intentions, in reality, this proposal ends up contributing to the very problem it seeks to solve.

Another costly effect of regulations is that they disproportionately harm small businesses. Bigger businesses often have the resources to deal with costs from regulations (or to twist regulations to their own advantage), but small businesses frequently do not. Regulations impose costs on businesses in the forms of both time and money, neither of which small businesses can afford to re-allocate if they want to remain competitive in their market.

Zero-Sum, Rent-Seeking Behavior

Regulations, then, decrease competition and shift the market towards monopoly in two ways. Not only do they incentivize companies to use government power to their own advantage and to the detriment of competitors, but regulations also bury small businesses in compliance costs.

Government regulations lead to what economists call “rent-seeking.” Rent-seeking, in this case, is when businesses divert their resources towards capturing a bigger portion of the existing wealth in a market instead of using their resources to create new wealth.

The less power the government has to regulate businesses, the less incentive businesses have to get in bed with the government. One of the defining characteristics of a free market is that it allows for the creation of wealth instead of merely the spread of existing wealth. In a free market, people can trade resources in a way that is mutually beneficial and produces a net gain for each party. But the introduction of government force into the equation shifts things towards a zero-sum game where one party benefits at the expense of another.

Government force, in the form of regulations, incentivizes this zero-sum, rent-seeking behavior. What this then leads to in a market is inefficiency, corruption, and less competition.

Economist Frederic Bastiat may have summed it up best when he said, “As long as it is admitted that the law may be diverted from its true purpose — that it may violate property instead of protecting it — then everyone will want to participate in making the law, either to protect himself against plunder or to use it for plunder.”

The solution to crony capitalism that logically follows from all of this is quite simple. The solution is to decrease and limit the scope of government power. The less power the government has to regulate businesses, the less incentive businesses have to get in bed with the government. If government intervention is decreased and limited to only what is absolutely necessary, we will see the problem of crony capitalism radically diminish in both frequency and severity.

Proposals for government regulations are a classic case of why policies must be based on more than merely good intentions. If one wants to evaluate a proposed policy, one of the best ways to do so is to consider the incentives that it will produce and the effects those incentives will have. Government regulations are a case where, although unintended, the results are very often negative.

Further Reading

{{article.Title}}

{{article.BodyText}}