Thursday, 27 March 2014

Measuring crony capitalism?

Well, it seems this too has become possible. The Economist decided to introduce an index of crony capitalism, where the index depicts billionaire wealth as % of GDP, however adjusted for sectors that have a higher probability of being "crony". I'm a bit skeptical towards such a measure. 

Before we go into more detail, read this short intro on rent-seeking from the article: 
"Inventing a better widget, tastier snack or snazzier computer program is one thing. But many of today’s tycoons are accused of making fortunes by “rent-seeking”: grabbing a bigger slice of the pie rather than making the pie bigger. In technical terms, an economic rent is the difference between what people are paid and what they would have to be paid for their labour, capital, land (or any other inputs into production) to remain in their current use. In a world of perfect competition, rent would not exist. Common examples of rent-seeking (which may or may not be illegal) include forming cartels and lobbying for rules that benefit a firm at the expense of competitors and customers.
Class warriors and free-market devotees alike are worrying about rent-seeking. American libertarians fear an elite has rigged their country’s economy; plenty of ordinary Joes reckon the government and Federal Reserve care more about Wall Street than Main Street. Many hedge-fund managers sniff that China is a house of cards built by indebted cronies."
And I agree. Becoming rich via innovation is one thing, but becoming rich via rent-seeking and asking for favors from the government is a completely different ballpark. The first should be encouraged as much as possible, while the second should be prevented at any cost. Unfortunately those who have the power to prevent cronyism and rent-seeking are very often the same ones who encourage it - politicians in power. Public choice theory explains very precisely why this is so. 

So how was the index for measuring cronyism assembled? They got the idea from several Indian economists and used Forbes data on world's billionaires who are more involved in rent-heavy industries. These industries are the following: casino business; coal, palm oil and timber; defense industry, infrastructure and pipelines; oil, gas and energy; banking industry (both investment and commercial); ports and airports; real estate and construction; steel, metal and commodities; utilities and telecommunications.

A brilliant list! Every single industry that depends highly on government support (I'm thinking of the biggest companies in such industries, mainly monopolies and cartels), many of which couldn't survive without political favoritism - think of defense, airports, steel, utilities, energy, and more recently investment banking after bailouts. It's not that the companies in such industries are corrupt, but they are certainly more prone to rent-seeking. All of these industries employ many lobbyists to get what they want from their governments, at least in democracies such as the US. In less democratic societies, you don't need lobbyists - people like Carlos Slim apply different methods to get what they want, making corruption rampant in such societies. 

I would add to this the drug industry as well. The war on drugs is another huge source of cronyism fueling vast money laundering schemes and police and political corruption. It is essentially a large rent-seeking business. However, I understand the exclusion - it's very hard to measure the wealth of drug lords.

They take the relative measure of the cronyism where they compare the rent-seekers' wealth to the country's GDP. They only take the 23 countries, so these are not the top 23, it's the entire sample.

It is obvious that developing countries experience much bigger problems with cronyism. Their high growth in the pre-crisis decades was build mostly on the rise of crony sectors (natural resource boom, construction boom) where a minority of the well-connected businessmen and politicians took most of the benefits. Recall this story from an earlier text of mine analyzing the protests in Brazil, Turkey, and the like. It's far from surprising that Russia tops the list. Their oligarchs created during the transition in the 90s are a prime example of cronyism and state capitalism. Putin didn't do much to stop this, he just switched their power to himself. It's no surprise to see Ukraine and Mexico close to the top either.

What is surprising to me are Hong Kong and Singapore. It seems that despite their efficient governments and institutional strength (the rankings are in the white square on the right), their billionaires are mostly from crony sectors. This probably has to do with size of their economies (scarce land boosts property values), or perhaps the fact that both of them are major international ports transferring a lot of traffic. In a proper econometric analysis one would certainly control for such factors.  

Contrary to expectations China scores pretty well. The explanation is that most of the banks and natural resource industries are owned by the state, which biases their crony figures downwards. 

On the other hand, the US has also done well on the index, having most of its billionaires coming from the IT industry, retail and many other real sectors of the economy. Contrary to popular belief not a lot of investment bankers or financiers are up there. This is something I've pointed out in one of my older texts on the blog

However in making the index they were very aware of its shortcomings: (1) not all cronies make their wealth public (the drug lord problem), (2) some sectors they characterized as rent-seeking may be more open to competition in certain countries, and vice versa - some open industries may be more subject to rent-seeking, and (3) only the wealth of billionaires is accounted for. Cronyies may not be billionaires, they can be multimillionaires - it's still rent-seeking and it's still huge. Hence my initial skepticism towards the idea of trying to measure it. I would say it was a decent effort, I certainly like the approach used, but the picture could well be much different. Now there's a good idea for future research efforts - how to measure cronyism more precisely.


  1. Vuk, there is a new website dealing with cronyism among other hot topics like Counterfeit GDP Growth, Bubble Finance, Abenomics etc. It's David Stockman's Contra Corner.

    1. thanks for this! it's a very good website