Back when first cutting my teeth on the concepts of free-market economics, I was impressed by the argument that business firms have to satisfy their customers to survive. Firms have strong, natural disincentives against performing poorly or acting immorally because they would risk losing customers and going out of business. For some time thereafter, I defended "business" on those grounds. Business is not an evil, I argued; indeed, businesses are almost "slaves" to the shifting and elusive passions of the sovereign consumer.
But over the years, I found myself forced to refine my views regarding business firms. Three lessons stand out. First, being "pro-business" is not the same as being "free-market." Second, regulation, which presumably works "against" business, goes hand-in-hand with special privileges and artificial protections "for" business. Third, the phenomenon of active and routine collusion between business and government made the business world seem less than the pure and benevolent social agent I once perceived. In short, I began to recognize that the concept of "the corporate welfare state" goes a long way to describe some of the problems we observe in the complex nexus between the market sector and the government sector. All too often, businesses lobby government for special privileges they would not have in a true, free market.
What Is Pro-Business?
Much political rhetoric over the past decade has centered over whether a particular policy is "favorable to business," or whether a candidate is "pro-business." In earlier years, I rooted for any "business-friendly" policy move, and supported conservative "pro-business" politicians. But, as I learned over the years, "pro-business" ideas are all too often inconsistent with "free-market" ideas.
When politicians speak about being "pro-business," they try to create the impression they will do things to benefit the business climate. That help, however, can come in two forms. One form is in the promise of deregulation, or a promise to fight new regulations or taxes that will potentially harm the economy, an industry, or a firm. This is generally all to the good; the help is "negative"; that is, the politician will focus on what the government should not do regarding a business's activity.
But the second form of "pro-business" help is "positive," that is, the state takes some action that specifically helps a business or an industry, usually at the expense of other people. The government creates some law or regulation that allows a business to do or have something it could not otherwise do or have in a true free market. It grants what amounts to a privilege.
That distinction might seem clear. Yet, as The Economist put it, "businessmen themselves-torn between a desire to be left alone and an appetite for special favors-are often unsure quite what they want from government."
Examples of Privilege
Bailouts. Clear-cut examples of artificial, government-granted privileges include bailouts, such as when a large firm or industry is losing money. The government gives the failed entity cash or cheap loans, or allows it to write off its creditors without liability, so it can resume business despite its poor performance. Recent examples include banks and auto manufacturers.
Subsidized loans. Some sectors are perpetually propped up, regardless of their condition. For example, government offers "small businesses" subsidized loans at below-market interest rates, with the taxpayer assuming the risk. When government-assisted "small-business investment companies" fall, these "venture capital" firms simply declare bankruptcy before the government's Small Business Administration can file a claim on the assets.
Outright "disincentive" subsidies. Another clear example of privilege is subsidies in which an outright payment occurs. For example, agricultural corporations get every kind of corporate subsidy imaginable, including dairy price supports, export-enhancement programs, and payments for not growing certain crops.
Resource privileges. Other privileges include special deals for ranchers, oil companies, and lumber companies to graze on, drill in, or cut resources from federally owned lands at drastically reduced prices. They get those deals not only because the government is reluctant to sell any of its vast land holdings, but because firms in those industries are unwilling to buy the land for what it's worth, or to pay full price for the resources they use.
Monopoly privileges. Another example of privilege is cable companies and utilities that get granted exclusive monopolies over their regions, using the law to outlaw systematically any competition.
Trade protection. Businesses argue for restricted competition at the international level, too. Many large corporations saw the North American Free Trade Agreement (NAFTA) as a vehicle for securing "compensatory" protections and other favors. The administration "negotiated concessions" for flat glass, durum wheat, home appliances, wine, peanuts, textiles, sugar, and citrus and vegetable interests, all "politically sensitive industries" that needed "relief."
Large businesses have often supported labor, zoning, permit, safety, or other regulations designed to keep out low-cost competitors, because the bigger firms were already meeting those new requirements anyway.
As The Economist reports, "Regulation offers ways not just to create markets but also to compete with rivals. Firms have learned to lobby for rules that bring them benefits. Established companies . . . may lobby for stricter standards, knowing that these will mainly affect new entrants. Companies lobby for standards which they can meet, but impose high costs on competitors."
A classic case of that is underway with regard to environmental regulations. In fact, The Economist continues, companies in this area "press for regulations that will create a market for their products. Companies selling low-sulphur coal have rooted for legislation to reduce acid rain." And waste management firms have fought to maintain and strengthen environmental regulations, including new landfill restrictions, waste incineration standards, and licensing schemes to keep out competitors. The Clinton Administration's smog-control plan is designed to mandate a greater market share for ethanol, "and is likely to boost further the fortunes of Archer-Daniels-Midland Co., the politically active agricultural company that dominates the ethanol market." ADM did no direct lobbying on the issue, but "didn't have to." Competing industry groups charge that ADM's influence was indirect, primarily through The Renewable Fuels Association, a trade group.
It's routine. One insurance executive noted, "It's common in our industry: Large companies support legislation to drive out small competitors."
Drawing the Line
All of those privileges are perfectly legal, as business lobbyists and activists quickly point out. But legal doesn't mean moral. One Texaco executive, for example, feels uncomfortable drawing a hard line between lobbying against bad regulation and lobbying for special privileges. He used the old "what's-good-for-General-Motors-is-good-for-America" argument. His analogy was, "If growing wheat happens to be good for the nation, then it's okay to say so [in your lobbying efforts], even if you're a farmer."
The Harm to Others
When the harm to consumers and taxpayers is considered, however, that claim of morality is harder to defend. To free-market advocates, such privileges are not the proper function of government. Ethical businesses should sink or swim on their own, without any help or harm from government. That is, the proper pro-business stance is "negative" (i.e., the state should leave me alone). A "positive" stance (i.e., the state should do me a favor) is improper. Those favors or privileges would not exist in a true free market without government intervention. They can be granted only at the expense of others: taxpayers, consumers, or other businesses.
Tax Breaks: Are They "Subsidies"?
Some privileges or exemptions are slipperier to define. A good example is tax breaks. It remains an open question among free-marketeers, if an industry lobbies for and receives an extra tax deduction that some other industries don't get, whether or not that runs counter to free-market principles. Some would argue that anybody who can get a break from burdensome government taxation should accept it, and should feel no moral guilt about keeping money away from a wasteful, corrupt bureaucracy. Also, as one of my colleagues explained, every $1.00 in tax revenue leads to $1.83 in new spending. Every dollar you keep from government, therefore, prevents another 83 cents in deficit borrowing. Tax breaks are a moral and economic good.
Others would argue, on the basis of "equal protection of the laws" that the same breaks should go to all industries; if not, they should be opposed. Seeking and accepting a special tax break is "unethical."
A Wall Street Journal editorial, focusing on the "industrial subsidy game" played by state and local governments, recently tackled this tricky issue. "The cleanest line we can draw . . . is between enterprise that is subsidized and that which isn't." The editorial faulted the city of Austin, Texas, for giving a tax break to Apple Computer on the following grounds: "As long as . . . localities go bidding for business with funds that must be raised from other taxpayers, then the objections of other citizens must be weighed" [Italics added].
The editors have a point: Many argue that government will spend what it will spend. Perhaps more taxes mean more spending. But lower taxes do not mean the government will spend less. Thus, lowering taxes for one person means more taxes paid by another (perhaps by someone in the future, if the deficit is made up by borrowing that must be repaid in the future). Under this argument, a tax break is indeed a subsidy.
A New Look at Tax Subsidies
Whether tax breaks are improper privileges or not, they seem increasingly unpragmatic, even to policymakers. Some mayors of large cities abhor the idea "that politicians can create jobs by handing out temporary tax bribes to companies" to spur a city's economic activity. The Heartland Institute wrote "there is growing consensus among experts and the general public" that tax abatements and subsidies "are an unsound investment."
Businesses, too, are learning those tax breaks can backfire. A Michigan judge recently barred General Motors Corporation from closing its Ypsilanti assembly plant, on the grounds that GM's acceptance of Michigan's tax abatement program was "a promissory estoppel," a contract or implied promise to keep the facility operating in exchange for relief on its taxes. Tax breaks have strings attached. Perhaps business managers will think twice before looking at tax subsidies as some "free lunch."
Regulation and Privilege
Despite a little difficulty in defining privilege, we can say that regulation and privilege are two sides of the same coin. And, to extend the analogy, performing the regulation-privilege coin trick requires a balancing act and a vicious cycle.
All large industries now face regulations and privileges. If the restrictions cost more than the privileges are worth, the industry suffocates, leaving nothing to tax or regulate. If the value of privileges exceeds the cost of the restrictions, then the industry takes advantage, and abuses occur for which regulators are blamed. Balance is crucial. If regulators take the heat, they impose more regulations. But those hurt industry profits. The industry in turn complains to regulators, legislators, and staffers. The government, instead of removing the restrictions, offers privileges to offset or compensate for the regulatory burdens. But those privileges lead to excesses and abuses, which lead to more call for re-regulation, and the cycle continues.
The classic example is the S&L industry. For decades after the 1930s, the S&L business suffered harsh regulation but enjoyed the offsetting privileges of deposit insurance and legal protection from competition. The system contained its inherent problems because the two were roughly balanced. The Depository Institutions Deregulation and Monetary Control Act of 1980 removed some of the industry's burdensome regulations, yet it increased the privilege of deposit insurance, boosting coverage to $100,000 per account from $40,000. Regulation and privilege became unbalanced, so the industry abused the privilege of taxpayer-backed deposit insurance, and taxpayers got stuck for $170 billion.
Regulation as an Access Window
A lot of that business begging is done by firms that are heavily regulated. Indeed, many argue, that regulation is precisely what hindered their competitiveness and threatened their health. But how do regulation and privilege get so intertwined?
Basically, businesses get entrenched in the process. Once regulated, an industry opens an "access window" to the political process, via lobbyists and trade associations. After all, it must defend itself against bad regulations.
But these meetings are hardly knock-down, drag-out fights. At hearings, business and politicians usually play a polite, conciliatory game. The industry often "agrees that reform is needed." It acknowledges the laudable intention of the new government regulation, but questions only some of the technical language in the clauses. The regulated industry rarely fights to defeat an entire measure. Instead, it focuses its resources only on opposing or rewriting some technical language in one or two sections of a proposed bill or regulation. They know that the regulations and laws will harm them. But they will eventually lead to some later concession or compromise, or better yet, an outright privilege that will benefit them later. The window works both ways.
An article by Gary S. Becker, a 1992 Nobel laureate and professor of economics at the University of Chicago, said, "The best way permanently to reduce undesirable business influence over the political process: Scrap all the regulations that serve as little more than tollgates for graft."
Seeking Safe Harbors: The Gray Area
Often that concession or compromise helps a business or industry simply define what it can or cannot do. Frequently, businesses lobby Washington to help redefine some previous regulation that was poorly written, or has not been flexible enough to accommodate new technology or new trends. Much lobbying involves updating, revising, or amending old laws that are not relevant to current reality. Businesses constantly revisit old issues to redefine what is illegal and what is not, for they wish at least to act legally. They ask government for "guidance," "flexibility," "no-action letters," and "approvals of action" so that if a regulatory question comes up later, the business can respond, "The government said it was legal." Businesses need to know where they can find "official non-enforcement," "comfort levels," or "safe harbors," so they can proceed in their business with increased legal certainty, with clear and consistent definitions of the law.
Businesses also offer to help government write the laws and regulations so they make some logistical sense, so they are internally consistent, or so they have a chance of "working" in a technical sense. Examples of that type of business-government cooperation abound in finance, such as insurance and banking, especially with regard to accounting or actuarial matters. Regulations and laws written without industry input would otherwise be self-contradictory, infeasible, excessively burdensome or costly, or otherwise inconsistent with the reality of how the industry operates.
Businesses often bring in expert advisers from "the real world" to work on "technical working group meetings" and explain to officials why the new rules must be written very carefully. Government accepts input from business so it can say its enlightened, interactive, "give-and-take" process resulted in a regulation or law that "we can all live with," that "everyone had a say in," that was "even-handed" or "reasonable."
That close contact between business and government often leads to one business gaining some regulatory privileges or advantages over another. During those technical draftings of a bill, a business can slip in a provision that (perhaps even unbeknownst to the regulators) will indirectly harm its competitors.
Much of the time, however, businesses are not trying to harm or defraud anyone. They're not looking for permission to rob or defraud people. They just want better definition of the laws, because they are so numerous, so comprehensive, and so pervasive. Businesses want legal confidence so they can form expectations and plan ahead.
The Revolving Door
The people who participate in that process can then pass through the "revolving door." Businesspersons with expertise at dealing with government on technical industry issues find themselves candidates for jobs as regulators, who can work well with their former industry compatriots. Hiring experienced people from an industry allows the government to say it is being "reasonable" and wants to get the regulation "right." Regulators, with experience at dealing with industry executives, in turn find opportunities as corporate government-relations directors or lobbyists in trade associations.
Many in business and government see this whole process, which has evolved over centuries, as simply "the way things are done" and the only way to have any influence over what happens between business and government. If a business stands on principle and lobbies vigorously against every new law or regulation, it is seen as hostile and stubborn, unwilling to compromise, unwilling to "play the game." Regulators see that behavior as a business's way of saying it doesn't want to be invited back to the hearings next time. Nonetheless, Stanley S. Arkin, a New York attorney, believes "resisting governmental authority may be an act of social responsibility for corporate America. Companies that stand up . . . and fight . . . are performing a patriotic duty by resisting the arrogant and undeserved application of . . . law."
Still, a business or industry that shuns the very process that writes its industry's regulation would find itself stranded, having cut off its avenue of influence and information. That can be good and bad. It might prevent it from lobbying for privileges. But it will also prevent it from lobbying against future ill-conceived regulations. It works both ways. Lobbying for deregulation is tantamount to lobbying for fewer privileges.
So businesses tend to just let things go as they have in the past. Most of the action is in that "gray area." Is that middling type of lobbying good or bad? It depends. If businesses use that access window to write regulations that harm their competitors unjustly, or at consumers' expense, then they are abusing the process.
The phenomenon of using the regulatory process to one's advantage is nothing new. Economists years ago labeled it "the capture hypothesis." Says one textbook,
The capture hypothesis assumes that regulatory agencies are set up in the interest of the firms to be regulated and that regulators serve the interest of regulated firms (who have "captured" them through the political process), not consumers. The capture hypothesis turns on its head the idea that economic regulation is designed to protect the public interest from monopoly. It is easy to point to examples of industries that like being regulated [such as airlines, telephones, and trucking].
Companies that "like" being regulated are entrenched neck-deep in the political process, opening up room for abuses more blatant than just legal subsidies and protections. Becker wrote:
Corruption is common whenever big government infiltrates all facets of economic life. In modern economies, profits often are determined more by government subsidies, taxes, and regulations than by traditional management or entrepreneurial skills. Huge profits ride on whether companies win government contracts, get higher tariffs and quotas, receive subsidies, have competition suppressed, or . . . have costly regulations suppressed.
Companies respond to the importance of government's role by striving to influence political decisions. It is often effective just to lobby politicians, and . . . bribe officials and politicians in return for government favors and profits.
Yet protections and subsidies, even bribes, can ultimately destroy the targeted industry. As I wrote on S&Ls and banks, "Many bankers still want the privilege of [deposit-insurance] coverage but also want fewer regulations. [They] cannot have it both ways. They must choose, and soon, either to stagnate as wards of the state in an unpredictable political process, facing eventual demise, or to be free and responsible institutions."
Paul Weaver of the Hoover Institution, in a book review, summarized: "Many corporations . . . lobbied hard to make sure government's interventions in the economy yielded limits on competition, subsidies, and other business advantages. [It is] a hard-to-accept truth: business is a major source of the anti-market thinking and policies that make a lot of big companies unable or unwilling to cope in a competitive world."
A Needed Change in "Business Ethics"
Business firms don't seem to make much effort to separate themselves from the political process. Perhaps the growing number of socially responsible consumers and investors would flock to the products and stocks of firms that made a point of distancing themselves from all forms of business-government collusion. Imagine the following advertising pitch:
We don't accept government subsidies, bailouts, low-cost loans, insurance, or other privileges. We don't lobby for laws that hurt our competitors. We actively oppose protectionism and invite all foreign competitors to try to underprice us. We do not lobby for tariffs, quotas, or anti-dumping laws. We do not support the government's budget deficits: Our treasury department holds no government or agency securities.
But for now, it seems that no such firm exists. Business-government collusion is a fact of the real world. It is possible only because the government has written so many detailed, intrusive laws in its perpetual attempt to micromanage all of our business activities. And government has a habit of applying these laws in arbitrary and capricious manner. That process allows some greedy businesses systematically to empower themselves at others' expense, using political pull to garner favors they could not otherwise have in a free market.
Those businesses must learn that people will learn to respect them if only they end their dependence on government privilege, and stand up on their own feet and face the economic reality of the world on their own terms.
1. "The slings and arrows of outrageous fortune," The Economist, October 30, 1993, p. 25.
2. See, for example, Virginia I. Postrel, editorial, "Populist Industrial Policy," Reason, January 1994, pp. 4,6; John R. Emshwiller, "How to Lose Federal Millions and Owe Nothing," The Wall Street Journal, February 15, 1994, p. B1; Jeanne Saddler, "Agency Demands Restrictions on SBIC Bankruptcies," The Wall Street Journal, February 22, 1994, p. B2.
3. See, for example, "Grotesque: A Survey of Agriculture," The Economist, December 12, 1992, pp. 1-18; Chris Warden, "Do We Help Farmers Too Much?," Investor's Business Daily, July 29, 1993, pp. 1-2; and James Bovard, "Welfare for Millionaire Farmers," The Wall Street Journal, May 22, 1990, p. A22.
4. See, for example, "Cowboy socialists," The Economist, March 6, 1993, p. 16.
5. Thomas W. Hazlett, "Who's Behind the Cable Scam," The Wall Street Journal March 30, 1990, p. A10; and same author, "Why Your Cable Bill Is So High," The Wall Street Journal, September 24, 1993, p. A10.
6. See Bob Davis, "Clinton to Propose Nafta Bill Offering Trade Relief to Some U.S. Industries," November 3, 1993, p. A2; Bob Davis and Jeffrey H. Birnbaum, "Clinton Strikes Mexico Deals On Trade Pact," November 4, 1993; Jackie Calmes, "How a Sense of Clinton's Commitment And a Series of Deals Clinched the [NAFTA] Vote," November 9, 1993, p. A9.
7. "Regulate us, please," The Economist, January 8, 1994, p. 69.
9. Timothy Noah, "Smog-Control Plan to Emphasize Ethanol," The Wall Street Journal, December 15, 1993, p. A18.
10. Timothy Noah, "Ethanol Boon Shows How Archer-Daniels Gets its Way in Washington With Low-Key Lobbying," The Wall Street Journal, December 29, 1993, p. A10.
11. Randal Suttles, chief financial officer of Golden Rule Insurance Co., in 1992 phone interview.
12. Allen Krowe, vice chairman and chief financial officer of Texaco, quoted in Eric-Charles Banfield, "Powerful Persuaders," Treasury and Risk Management, Summer 1993, p. 21.
13. Review & Outlook, editorial, "Bite of the Apple," The Wall Street Journal, December 9, 1993, p. A14.
14. "Radicals at work," The Economist, November 6, 1993, p. 19.
15. Joseph L. Bast, "Corporate Subsidies and Illinois' Demise," A Heartland Perspective, October 19, 1989, p. 1.
16. Jacqueline Mitchell, "Judge Bars GM From Closing Factory in Michigan, Citing Local Tax Breaks," The Wall Street Journal, February 10, 1993, p. A3.
17. Eric-Charles Banfield, "Deposit Insurance Is a Dead End," American Banker, September 16, 1992, pp. 4, 7.
18. Gary S. Becker, Economic Viewpoint, editorial, "To Root Out Corruption, Boot Out Big Government," Business Week, January 31, 1993, p. 18.
19. See, for example, Phillip D. Brady, Regulatory Chokehold, "Our Friend, the Revolving Door," The Wall Street Journal, n.d., circa 1993.
20. Stanley S. Arkin, "Be a Good Corporate Citizen: Fight the Feds," The Wall Street Journal, March 13, 1990, p. A18.
21. Stanley Fischer, Rudiger Dornbusch, and Richard Schmalensee, Introduction to Microeconomics, 2nd. ed. (New York: McGraw-Hill, Inc., 1988), p. 237. The authors cite George J. Stigler, "The Theory of Economic Regulation," Bell Journal of Economics and Management Science, Spring 1971; and James Q. Wilson, "The Politics of Regulation," in J.Q. Wilson (ed.), The Politics of Regulation (New York: Basic Books, 1980).
22. Becker, loc. cit.
23. The Wall Street Journal, May 24, 1989.
Mr. Banfield is owner of Banfield Analytical Services in Westmont, Illinois. As an adjunct policy analyst for the Heartland Institute, he has testified before the National Association of Insurance Commissioners, The Illinois General Assembly, and a U.S. Republican Hearing on health-care reform.
The views expressed are those of the author, and not necessarily those of the Nassau Institute (which has no corporate view), or its Advisers or Directors.