I do not mean the system we have now.
In 2008, the United States housing bubble finally burst, causing the world economy to fall into recession. Banks responsible for mortgage-backed securities reported significant losses as mortgage-backed securities plummeted in value. These securities were designed as a way for investors to invest in the U.S. housing market. The fall of home prices made foreclosure financially sound, as the homes became worth less than the mortgage loans they were bought under. As financial institutions suffered, credit tightened which put pressure on foreign and domestic automakers. Domestic automakers suffered the most because this crisis came at a time when their business models were losing market viability.
In a free market, the results would have been a simple matter of cause and effect. Banks and auto companies that adopted unsound business models would have inevitably failed in the long run. The companies would have had to undertake significant restructuring efforts, possibly under Chapter 11 bankruptcy code, or else face liquidation. As we all know, this is not what happened. Instead, the United States government instituted what we know as the bailouts. The auto bailout was met with a divided public response: Gallup polling in March of 2009 showed 59 percent of the population disapproved of the auto industry bailout.
The public response to bailouts is understandable. If small businesses or individuals bring themselves to financial ruin, they don’t seriously expect (much less receive) anything resembling the auto bailout. In fact, 200,000 small businesses vanished from 2008-2010 according to the U.S. Census Bureau. People on the left side of the spectrum were quick to label the recession and ongoing market stagnation as runaway capitalism, implying that it was capitalism that led us to a system where the government flagrantly picks winners and losers based on the size of the company (i.e., too big to fail), a system where being a large (or symbolically American) enough company gives you a special set of market rules. Such a system, however, is not runaway capitalism. In fact, it’s not capitalism at all, but an illusion of capitalism we know as cronyism. Cronyism is rife with long-term economic and social consequences.
The economic consequences of cronyism are perhaps the most intuitive. By creating a system where political favor allows companies to survive, aspects like product value and business model take a backseat to clout. This inevitably leads to products that are not profitable in a free market. In the auto example, Chevrolet (part of General Motors) produced the Chevy Volt, which costs a whopping $41,000, before a $7,500 federal tax credit. Even with government favors, the car is still too expensive to be viable in the market. In the first two months of 2012, 1,626 Volts were sold, putting GM far behind its 2012 sales goal of 45,000. Companies that survive on clout create an unfair playing field. If I am a young and ambitious financial mind and I decide to start my own bank/investing arm, how exactly am I supposed to compete against companies that are not only larger and better known than mine (which is fair because they earned it), but are also capable of bending the rules of the market through political clout? It’s the moral equivalent of running a marathon in which the guy you’re running against has a motorcycle because he and the referee went to the same high school.
Though the economic realities of cronyism are visible, the social consequences are more subtle and pointed out less frequently. When public officials claim to love a system of free enterprise while playing political favorites, they breed cynicism not only for our political system, but also for our economic system. It becomes difficult if not impossible to tell the difference between those who became rich and successful through merit and good trade and those who made their money dishonorably. It leads the public to believe that free markets themselves are the problem, that corruption and greedy short-sightedness are the inevitable norm for a capitalist society. Worse yet, generations of young and talented people become disillusioned with a system that was supposed to be an environment in which they could thrive.
When I say capitalism, I mean a system in which trade is truly free, where ideas, products and capital are exchanged on their merits and on their merits alone. I mean a system where the little guy has as much of a right to be successful and earn money as anyone.
Michael Cook is a Pratt senior. His column runs every other Monday.