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July 17, 2014

A Reply to the Rubins on Crony Capitalism

By

Paul H. Rubin and Joseph S. Rubin advance the provocative position that some crony capitalism may be welfare enhancing. With all due respect, I am not convinced by their defense of government-business cronyism.  “Second best correction” arguments can be made with respect to ANY inefficient government rule.  In reality, it is almost impossible to calibrate the degree of the distortion created by the initial regulation, so there is no way of stating credibly that the “counter-distortion” is on net favorable to society.  More fundamentally, such counter-distortions are the products of rent-seeking activities by firms and other interest groups, which care nothing about the net social surplus effects of the first and counter-distortion.  The problem with allowing counter-distortions is that firms that are harmed thereby (think of less politically connected companies that are hurt when a big player takes advantage of Export-Import Bank subsidies) either will suffer, or will lobby (using scarce resources) for “third-line” or “tertiary” distortions to alleviate the harmful effects of the initial counter-distortions.  Those new distortions in turn will spawn a continuing series of responses, causing additional unanticipated consequences and attendant welfare losses.

It follows that the best policy is not to defend counter-distortions, which very seldom if ever (and then only through sheer chance) appropriately offset the initial distortions.  (Since the counter-distortions will be rife with new regulatory complexities, they are bound to be costly to implement and highly likely to be destructive of social surplus.)  Rather, the best, simplest, and cleanest policy is to work to get rid of the initial distortions.  If companies complain about other policies that hurt them (generated, for instance, by the Foreign Corrupt Practices Act, or by Food and Drug Administration regulatory delays), the answer is to reform or repeal those bad policies, not to retain inherently welfare-distortive laws such as the Ex-Im Bank authorization.  The alternative approach would devolve into a justification for a web of ever more complex and intrusive federal regulations and interest group-generated “carve-outs.”

This logic applies generally.  For example, the best solution to the welfare-reducing effect of particular Obamacare mandates is not to create a patchwork of exceptions for certain politically-favored businesses and labor groups, but, rather, to repeal counterproductive government-induced health care market distortions.  Similarly, the answer to an economically damaging tax code is not to create a patchwork of credits for politically-favored industries, but, rather, to simplify the code and apply it neutrally, thereby promoting economic growth across industry sectors.

The argument that Ex-Im Bank activities are an example of a “welfare-enhancing” counter-distortion is particularly strained, given the fact that most U.S. exporters gain no benefits from Ex-Im Bank funding, while the American taxpayer foots the bill.  Indeed, capital is diverted away from “unlucky” exporters to the politically connected few who know how to play the Washington game (well-capitalized companies that are least in need of the taxpayer’s largesse).  As stated by Doug Bandow in Forbes, “[n]o doubt, Exim financing makes some deals work.  But others die because ExIm diverts credit from firms without agency backing.  Unfortunately, it is easier to see the benefits of the former than the costs of the latter.”  In short, the recitation of Ex-Im Bank’s alleged “benefits” to American exporters who are “seen” ignores the harm imposed on other “unseen” American companies and taxpayers.  (What’s more, responding to Ex-Im Bank, foreign governments are incentivized to impose their own subsidy programs to counteract the Ex-Im Bank subsidies.)  Thus, the case for retaining Ex-Im Bank is nothing more than another example of Bastiat’s “broken window” fallacy.     

In sum, the goal should be to simplify legal structures and repeal welfare-inimical laws and regulations, not try to correct them through new inherently flawed regulatory intrusions.  In my view, the only examples of rent-seeking that might yield net social benefits are those associated with regulatory reform (such as the expiration of the Ex-Im Bank authorization) or with the creation of new markets (as Gordon Brady and I have argued).

 - Alden Abbott is the Deputy Director of the Edwin Meese III Center for Legal and Judicial Studies and the John, Barbara, and Victoria Rumpel Senior Legal Fellow.

Originally appeared in Truth on the Market

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