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Thursday, June 22, 2017

Bloomberg: The Wrong Kind of Entrepreneurs Flourish in America

The Wrong Kind of Entrepreneurs Flourish in America

Crony capitalists seek to generate profits without producing anything of value.

Crony capitalism at work.

Photographer: Meridith Kohut/Bloomberg

When most people use the word "rent," they mean the price paid to live in a house or apartment. But when economists say "rent," they mean money that one person extracts from another without producing anything of value. When the government taxes people to give subsidies to companies, those subsidies are a form of rent. A monopoly generates rents from being able to jack up prices without being threatened by competition. Sometimes the government allows companies to get a certain amount of rent -- for example, the royalties from patents, which we protect in an attempt to encourage innovation.

Because it's just a transfer from one person to another, rent doesn't necessarily make an economy less efficient -- it's just often unfair. But Robert Litan and Ian Hathaway, writing in Harvard Business Review, have a more dire hypothesis. They surmised that many American entrepreneurs are no longer looking for ways to produce more useful stuff, and are instead looking for new techniques for extracting money from each other and from the government. In other words, crony capitalism may be slowly cannibalizing productive capitalism.

Litan and Hathaway draw on an argument by the late economist William Baumol, who warned of the possibility that entrepreneurs could turn their energies toward useless rent-seeking. As examples, Baumol cited historical cases of businesspeople who found novel ways to sue their competitors out of existence. Litan and Hathaway, noting a slowdown in U.S. entrepreneurship, fear that something similar might be happening  today. If big companies are using new and creative ways to crush the competition, it's bad news for economic dynamism -- it means fewer new products will be brought to market, and fewer hidebound old industries will be disrupted.

It could also mean that U.S. industries have been getting more concentrated across the board:

Industrial concentration, also known as oligopoly, tends to lead to higher prices and less economic output. It can also increase inequality and shift income from workers to company owners. There are a number of reasons the economy could be entrenching a smaller and smaller number of big corporations, but crony capitalism could definitely be part of the story. The rent-seeking entrepreneurship that Baumol warns about could easily be carried out by big companies.

So which companies are sucking rents out of the productive economy? Litan and Hathaway don't point fingers, but it's easy to make an educated guess. In an influential 2014 paper, Thomas Philippon speculated that financial industry profits and salaries rose spectacularly since 1980 because banks, securities firms and fund-management companies found new methods for extracting rent. There are a number of ways this could happen, from the implicit bailout guarantees given to too-big-to-fail banks to high-frequency trading systems designed to beat the competition by nanoseconds. I suspect that hidden money-management fees might be another mammoth source of rents.

Patents might also be playing a role. Economists such as Alex Tabarrok, as well as many others from politics and industry, have been arguing that the U.S. patent system has changed from a healthy facilitator of scientific breakthroughs to a heavy hand of government regulation that shelters dominant corporate giants. Patenting of software, business processes and product design has reached absurd levels -- in 1999, Inc. won a patent for the "innovation" of one-click online shopping, and in 2012 Apple Inc. received a patent for the idea of rectangular handheld devices with rounded corners. Big companies are shelling out increasingly big bucks for patents, just to shield them against competitors' lawsuits. Against that amount of cash, plucky startups have no chance.

Regulation could be a big drag as well. Eager both to shield workers from obsolescence and to appease corporate lobbyists, many U.S. states have enacted laws to protect established industries from new market entrants. Some states forbid car companies from selling directly to buyers, while others protect credit-card companies by banning retailers from passing on swipe fees. Though one study has cast doubt on federal regulation's role in reduced entrepreneurial dynamism, state regulation could be a much bigger deal.

Another source of rent is corporate subsidies. Local governments often pay companies to keep their offices and factories close by. This may help keep production in the U.S., but it's a form of rent all the same. And if different U.S. states or cities compete against each other in bidding wars when a business relocates or plans a new factory or office, it's a zero-sum game that merely sucks money out of taxpayers' pockets and delivers it to corporate coffers.

This isn't an exhaustive list of all the ways that companies can use the government to siphon money from individual Americans and crush their small young competitors. But it should be enough to demonstrate that crony capitalism is a threat to U.S. productivity as well as fairness. In theory, liberals and conservatives should both oppose crony capitalism, since it hurts average Americans and reduces economic freedom at the same time. Let's hope legislators can put aside the rancor of this hyperpartisan age and work to end the favoritism that gives well-connected businesses an unwarranted advantage.

    To contact the author of this story:
    Noah Smith at

    To contact the editor responsible for this story:
    James Greiff at

    John Case
    Harpers Ferry, WV

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