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Saturday, January 24, 2009

"How Cronyism and Rent-Seeking Replaced 'Creative Destruction'"

Eliot Spitzer:

America's Fear of Competition, by Eliot Spitzer, Commentary, Slate: Although everybody claims to love the market, nobody really likes the rough-and-tumble of competition that produces the essential "creative destruction" of capitalism. At bottom, this abhorrence of competition and change are the common theme that binds together the near death of the American car industry, the collapse of the credit market, the implosion of the housing market, the SEC's disastrous negligence, the Madoff Ponzi scheme, and the other economic catastrophes of recent months.

Consider the examples of the SEC and GM, which would appear to have nothing to do with each other. The traditional critiques of the SEC have been that it was underfunded and didn't have up-to-date laws needed to regulate sophisticated financial transactions in evolving markets. That's not accurate. The SEC is a gargantuan bureaucracy of 3,500 employees and a budget of $900 million... And the ... powers of the SEC are so broad that it needs no additional statutory power to delve into virtually any market activity that it suspects is improper, fraudulent, or deceptive. ... The SEC has all the money and people and laws it needs. For ideological reasons, it just didn't want to do its job, and on the rare occasions when it did, it didn't know how.

GM's excuses—that its UAW contract and health care costs make it too top heavy to compete—are partially true but ignore a simple reality: These are the self-inflicted wounds of a company that chose a path of least resistance rather than confront the need for dynamism and innovation. ... The auto industry preferred protection to competition. And when it had to compete, it wasn't up to the task.

Both the SEC and GM refused to adapt from the world of the last century to the more dynamic new millennium. Each reacted the same way to competition: Instead of improving its product, it played defense. ... No one at the SEC seemed to ask the most important question: Given how the market is changing, what should we change to insure the integrity of the capital markets?

Instead, the SEC spent its energy preventing others from doing the work it should have done. Using the rather arcane doctrine of pre-emption, the SEC fought in the courts and on Capitol Hill to keep other enforcers at bay: Apparently, worse than having fraud in the marketplace was the possibility that an entity other than the SEC would appear to be more effective than the SEC at finding it.

For both the SEC and the auto industry, Congress was a place to find protection from meaningful competition. Each used its bureaucratic clout to insulate itself from the pressures of capitalism. ...

The result has been unfortunate: Over and over, we supplied the protection from needed change that these entities desired. Then, when the going got tough, neither the SEC nor GM was up to the task. By preventing the stern taskmaster of competition from forcing adaptation, we became complicit in their becoming dinosaurs. ... Both GM and the SEC need to see a change in market conditions as an opportunity—not a challenge to market share.

We must rebuild these two institutions. If we don't infuse them with a culture of change and love of competition, they will fail once again. ... This is a unique opportunity for President Obama and the Congress to take two seemingly different entities and force them to play by the real rules of capitalism...

Congress and the executive branch have, to a considerable extent, been devoted to business interests in recent years. In essence the argument is that what's good for business is good not just for America, but for the whole world. The ideological basis for this approach is that the interests of business and of greater society always coincide so that maximizing business interests maximizes social benefits at the same time, and that a hands off approach from government is the best way to allow those coincident interests to express themselves.

Unfortunately, however, this ideological foundation incorporated a flawed understanding of the interaction between market structure and social benefits, particularly the ability of markets to self-correct when the market structures deviate from the socially optimal structure. The result of this, particularly as it came to be applied in the political arena, contributed to the existence of cronyism, rent-seeking, institutions that became too big, interconnected, and too powerful to fail, and other problems. Political power combined with rigid ideology built upon a false premise - the doctrine of immediate self-correction by markets - gave us a result that was far from the competitive ideal presented in textbooks, a world that was far from the ideal competitive model that produces such large benefits for society.

I think there is some understanding that the approach of the past did not work, with the current state of the economy it's hard to argue that it did, and that we need to go in a new direction. And I'm sure we will try. But I wonder, when all is said and done, will anything really change?

    Posted by on Saturday, January 24, 2009 at 12:33 PM in Economics, Market Failure | Permalink  TrackBack (0)  Comments (61)


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