Wednesday, May 10, 2006

Bad Social Capital -- Crony Edition

Greg Mankiw links to a post at the Becker-Posner blog on "crony capitalism" in Latin America:

One legitimate reason for the opposition to capitalism in Latin America is that it frequently has been "crony capitalism" as opposed to the competitive capitalism that produces desirable social outcomes. Crony capitalism is a system where companies with close connections to the government gain economic power not by competing better, but by using the government to get favored and protected positions. These favors include monopolies over telecommunications, exclusive licenses to import different goods, and other sizeable economic advantages. Some cronyism is found in all countries, but Mexico and other Latin countries have often taken the influence of political connections to extremes.

Throughout the term, I was a pretty strong advocate for social capital investment. However, social capital certainly can be employed to produce socially inefficient outcomes. Cronyism is probably the worst aspect of social capital (the other big potential drawback to social capital is getting conned). Fear of the inefficiencies of cronyism has led to the stigmatization of nepotism and various regulations to prevent its spread (e.g., a friend of mine recently told me that his father's large international law firm has a total ban on hiring family members).

These restrictions and other regulations on lobbying and bribery are necessary. In competitive markets, the firm typically bears the cost of cronyism (i.e., paying more for a contract or hiring a low productive friend hurts the firm by making less competitive). However, in non-competitive markets and, particularly, in government, the cost of cronyism is bourne by society (for recent examples for the US see Cunningham, Duke; Brown, Michael; Abramoff, Jack; Jackson, Alphanso, ...). This is clearly bad especially if, as in Latin America, it leads people to want to restrict markets (as opposed to restricting cronyism).

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