Crony capitalism afflicts the economy: Why and remedies

Updated on 03/10/2018 - By InM - No Comments

The concept of 'crony capitalism' or 'cronyism' is closely connected with the idea of rent-seeking and corruption. It incorporates both an ethical judgment and a positive description of a feature of an economic process. Crony capitalism rests on the notion of plunder and bad governance whose purpose is to divert national wealth for personal and political use by influential groups. Further, it refers to a type of rent-seeking society where the rent-seeking structure is somehow legitimised. A rent-seeking elite, weak public institutions, a bureaucracy uninsulated from the meddling of politicians and vested interests, a political culture founded on coercion and patron-client relations, corruption, and absence of concern for redistribution serve as fertile grounds for persistence and growth of crony capitalism. The essence of crony capitalism is a relationship between business and politics.

Thus crony capitalism arises when business cronyism and related self-serving behaviour by businesses or business people spills over into politics and government, or when self-serving friendships and family ties between businessmen and the government influence the economy and society to the extent that it corrupts public-serving economic and political ideals. The manifestation of crony capitalism may take distinct forms depending on its level of development and the presence or absence of the rule of law. For example, the use of 'crony relations' is a mechanism through which property rights are secured in the absence of rule of law creating a crony and personal overlap. Often, in developed countries, corruption is a complement to the official economy rather than a substitute; whereas in countries like ours the situation is reversed.

In practice, crony capitalism manifests as a system in which those close to the political authorities who make and enforce policies receive favours that have large economic value. In the system, leading businessmen enjoy close personal relationships with key politicians. It enriches the privileged through use of political power. With crony capitalism, the person with political power joins hands with influential businesses to block competition for mutual benefit. Further, these people may award government contracts to their favoured businesses at inflated prices/compromised quality in order to collect a percentage.

Often the ruling elites find cronyism too handy in establishing legitimacy; and the businesses promoting the system can use it to ensure their hold over the economy's commanding heights. The collusion among business enterprises, government officials and ruling parties results in business-friendly policies and investments that serve private interests at the expense of public interest.

In a crony capitalism economy, businesses thrive through a return on money amassed through a nexus between the business and the political elites. This is done using state power to remove competition in handing out favours where the state exercises monopolistic control over public goods; for example, contracts for public works. Money is then made not merely by making a profit in the market, but through profiteering by 'rent seeking' using the monopoly or oligopoly. Entrepreneurship and innovative practices, which seek to reward risks, are stifled, since the value-added is little by crony businesses as hardly anything of significant value is created by them, with transactions taking the form of 'trading'. Crony capitalism spills over into the government and the politics and the nexus distorts the economy and affects the society. In its worst form, crony capitalism can devolve into simple corruption, and bribes to politicians and government officials are considered 'lawful' and tax evasion is common.

THE MIDDLE INCOME TRAP: Development literature shows that sustained growth in developing countries is often hampered by the middle income trap, where crony capitalism kills transparency and competition and creates oligarchies that slow down growth. The rich and the influential receive land and resources in return for payoffs to corrupt politicians. It substitutes vested interests for public interest. In countries like ours, the provision of public goods is mostly biased against access by the poor. The system also tolerates corruption. There is also a link between poor public service, patronage and corruption that grows more worrisome over time.

The massive losses due to alleged scams are prime examples of deeper rots that exist in Bangladesh's banking sector. In most cases, it is alleged that the banks are being milked dry by 'influential people' including politicians and their cronies. Many of the current problems in the financial sector and the huge non-performing loans (NPLs) of the banks (NPL ratio stood at 10.8 per cent in March 2018 compared with 9.3 per cent in the previous quarter) stem from the collusion and influence-peddling that happen during sanctioning loans. This leads to extensions, moratoriums and restructuring packages. With banks having directors and even independent directors appointed by the government, crony capitalism has its feet firmly stuck in the mess!

Most large borrowers are using the large loan restructuring package to avoid being tagged as loan defaulters. Bangladesh Bank (BB) has issued guidelines for large loan restructuring allowing more time for the borrowers who are unable to pay back their loans due to 'unavoidable circumstances'. However, there exist allegations regarding the misuse of this policy. In many ways, the policy opens up the floodgate for loan restructuring.

While there may exist a genuine business case for large loan restructuring, one also needs to be mindful that  excessive loan  concentration  poses  risks  for  the  overall  health  of  the  banking sector. This calls for strengthening the   monitoring   of   loan concentration  for  all  large  borrowers  with  a  view  to  ensuring  that  all  prudent  norms  are applied  for  these  borrowers  and   find  ways  to  reduce  such  concentration.  Although individual  bank-specific  single  borrower  limit  is  in  place  and  is monitored,  a  system  is needed  where  the  full  banking  exposure  of  both  an  individual  enterprise  and  a  group  of enterprises belonging to a single owner are monitored and prudent norms applied to both. 'Too large to fail borrower syndrome' is not a healthy development for a sound banking sector.

In our society, businesses compete for the goodwill of those in power, rather than the consumers. This is truer of those involved in big business; small business owners usually find a completely different, less-regulated environment. This allows those connected with power to tap into rich sources of corruption, including in public procurement, project implementation and tax administration. These governance failures have created an economy which is largely built around redistribution of rents that is excess returns above the normal levels  generated in competitive markets.

CORRUPTION INDICES, RULE OF LAW INDEX, HIGH-INCOME INEQUALITY: Since independence, Bangladesh has been struggling with widespread discontent over deep-seated corruption and state capture. Oligarchs dominate large sectors of the economy, extracting rents and exerting their influence on the state often through representation in Parliament. Further, politically connected businesses use various channels to access economic rents: public procurement, subsidised loans, transfers from the budget, trade regulations that restrict imports, privileged access to state assets through privatisations and beneficial tax regimes. 

Cronyism may rule widely in a country if it scores poorly (as Bangladesh does) on widely accepted corruption indices (such as Transparency International's Corruption Perceptions Index in which Bangladesh has a score of 28 out of 100 in 2017). In such cases, ruling parties and business elites work together in ways that increase their hold on power and wealth, and close off opportunities to the competitors. They may also be assisted by investments from foreign corporations, often in the energy or mining sectors, seeking to gain favour with local authorities in order to secure exploration rights.

Similarly, a country that lags on political pluralism, independence of its judiciary, gender equality, or human rights (like Bangladesh does), cronyism can be an active factor. The Rule of Law Index produced by the World Justice Project puts a value of 0.41 for Bangladesh in 2017-2018 indicating very low ratings on measures of government powers, absence of corruption, open government, fundamental rights, order and security, regulatory enforcement, civil justice and criminal justice. It is also held that if a country's economy is highly reliant on exports of raw materials or low value-added goods (like Bangladesh's dependence on readymade garments) rather than productivity or innovations, cronyism can become a dominant factor.

Moreover, high-income inequality that exists in Bangladesh can mean that cronyism plays a key role in reducing competition in the country's economy. The wealth that the ruling elites accumulate through cronyism also flows into the developed economies. The Tax Justice Network estimates that $12 trillion from developing countries alone was parked in offshore havens in 2016.

Real estate can function in the same way, through the sale of apartments in politically stable markets to the oligarchs from corrupt, emerging-market economies. The elites may also put a sizable portion of their assets in real estate in Western cities (e.g. 'Begumpara' in Toronto) or offshore bank accounts. A large share of these assets is funnelled to asset managers, hedge funds, and others in the large financial centres of the world. Pouring money into hedge funds and ultra-luxury real estate is often a poor investment choice, but to a wealthy oligarch, they are safer bets than keeping wealth in his or her home jurisdiction, where shifting politics heighten the risk of expropriation. That perhaps is the reason why our rich park their ill-gotten wealth in foreign banks and overseas assets.

Obviously, in no society it is acceptable when businesses gain wealth not through hard work but through 'well-oiled' connections fostered with the state and its corrupt politicians. The solutions are simple enough to preach but seemingly impossible to achieve. For example, it is important to improve regulation and enforcement - but this does not mean making more rules just for the sake of it - but to restrict the overbearing role that the government bureaucracy plays. Only a rule-based regime can ensure rewards on the basis of expertise and competency. Businesses should also learn to grow their wealth without the patronage factor. Cronyism is a common enemy, as it concentrates wealth with the favoured and deprives others from growing. 

Further, just because businesses are close to the state, this does not necessarily mean they must be, by nature, cronies. What is needed is a transparent, robust regulatory environment. Transparency and good regulation always help reduce the likelihood of cronyism.

As the economist Thomas Piketty points out, the concentration of wealth has grown steadily since 1980. Piketty shows that the percentage of income that accrued to the top remained near 30 per cent for three decades after 1950. But starting in 1980, this percentage grew steadily until today, when it is near 50 per cent. He maintains that although technology and the ability to leverage strong brands into new overseas markets have played a role, there is no doubt that people who are well positioned in extractive sectors have benefited disproportionately. Among them are executives of some commodities and financial firms.

Economic cost of crony capitalism is clear. The ultimate success of economic reforms in Bangladesh will depend in large part on overcoming resistance from vested interests to any efforts to establish a rule-based system and regulations. A strong Independent Anti-corruption Commission (ACC) is the first step of an effective anti-corruption framework. The government must also deliver on its promise of real change and transparent governance. These expectations are the strongest counterweight to corruption and state capture in Bangladesh.  Further, an engaged and vocal civil society is the country's best bet at breaking the vicious cycle of crony capitalism. After all, as we have learnt from Adam Smith, what is in the best interest of business is not always in the best interest of the individuals - and 'business friendly' is not the same as 'market friendly'!

Dr Mustafa K Mujeri is Executive Director, Institute for Inclusive Finance and Development (InM).

The Institute for Inclusive Finance and Development (InM) is registered as an independent non-profit institution under the Societies Registration Act 1860.
The Institute works for developing the overall capacity of the financial sector and strengthening the links between the financial and real sectors through undertaking research, training, education, knowledge management and other programmes in priority areas including inclusive finance, microfinance, poverty and development.

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