Crony capitalism or plain cronyism?

(first published in theSun on 26th March 2014 and can be accessed here.)

THE hallmark of a free economy is that it allows for perfect competition in a level-playing market where all players have access to both information and the buyers making purchasing or contracting decisions equally.

But we know that there are fundamental flaws in this assumption, especially so in countries which have strong state influence. This makes industry players heavily dependent upon the patronage of government bureaucracy since officials are more likely to grant favours when those favours are what make the crucial difference between winning and losing a tender.

This is certainly the case in Malaysia, which has a highly centralised government. So it did not come as a surprise when Malaysia ranked third globally in the Economist’s crony-capitalism index 2014, just after Hong Kong and Russia.

The index took the total wealth of billionaires earned in that country through sectors most vulnerable to monopoly, or that involved licensing or heavy state involvement, and calculated this relative to the country’s gross domestic product (GDP). Malaysia’s billionaires earned 18% of the country’s GDP, according to the index.

The rent-seeking sectors included casinos, energy (oil, gas, chemicals), coal, palm oil, timber, defence, infrastructure, real estate and construction, steel, utilities and telecoms services, and deposit-taking banking and investment banking – since all of these were more prone to graft and relied on awards by the state to businesses.

Although the index does admit there are flaws in its methodology for a number of reasons, this is a telling sign that even the freest economies suffer heavily from cronyism. Hong Kong tops the list, with Singapore in a close fifth place. And both of these are economies that do the best in the annual Economic Freedom of the World Index, which my think-tank heavily promotes. So what does this make of the so-called free economies of the world, if the countries’ wealth is respectively dominated by tycoons close to the state?

One might argue that the term “crony-capitalism” is oxymoronic. This point was contested heatedly in a recent Regional Liberal Colloquium that IDEAS hosted, since “capitalism” in its original meaning of the term represents a market in which its players operate on the rule of law, where all are equal before the law.

This is the complete opposite of “cronyism”, in which one set of players is granted biased favours in preference over another. It might therefore be more accurate to call it the “crony-pseudo-capitalism” index, or just plain “cronyism” index instead.

Semantics aside, one could also ask why this means anything at all. After all, countries that have high scores in the index still perform well in their economic growth (again, citing Hong Kong and Singapore). And in a free economy, isn’t it the case that there will bound to be winners and losers – entrepreneurs that work hard to ensure their businesses succeed and do so strategically would naturally more likely amass their wealth as opposed to those who made poor business decisions?

One could accept such a situation in which this set of hardworking entrepreneurs truly did earn their wealth through the sweat of their brow. Nobody faults an honest player who works his way out of poverty by engaging in private enterprise if he did so purely based on skill, ability and merit. Under such circumstances, each individual would be given an equal chance to seize such opportunities to climb the ladder.

But it is not acceptable when such businesspeople gain wealth not through hard work but through the well-oiled connections they have fostered with the state and its wily politicians.

The solutions are simple enough to preach but are seemingly impossible to achieve, even or perhaps especially here. First, monopolies should not be allowed to flourish the way they do. The Competition Act was enacted with the purpose of legislating for greater competition, but still does not deal with many industries in which monopolies still exist, for instance in telecoms, media, rice, satellite television and airline services. In this respect, Pakatan Rakyat’s election manifesto had the foresight of proposing an anti-trust law and commission to levy fines and break up companies against monopolies and oligopolies.

Second, it is important to improve regulation and enforcement – and this does not mean making more rules just for the sake of it – but to restrict the overbearing role that government bureaucracy plays, for example in the awarding of licences. A rules-based regime would ensure that licences are given out on the basis of expertise and competence. Once a company satisfies these rules, there should be no reason that personal, discretionary (and more importantly, political) influence is used to choose one over another.

It is significant to note that the sectors chosen by the Economist are also those that Malaysia depends heavily on for our economic growth, namely energy (oil and gas), real estate and increasingly so banking and investment banking.

It would be interesting to determine just which billionaires would be considered as cronies in our context.

Finally, it is also important to analyse countries that did very well in the index like France and Germany. Two factors can be considered here: one, that billionaires in these countries did not depend on the state for growing their wealth but made their money “largely from retail and luxury brands” without the patronage factor.

Two, just because industries are close to the state, this does not necessarily mean they must be, by nature, cronies.

What is needed in this case is a transparent, robust regulatory environment as mentioned above. Even what critics consider to be natural monopolies – in which it is assumed that it is most efficient for production to be concentrated in a single firm – transparency and good regulation would help reduce the likelihood of cronyism.

In fact, there is also debate that these industries (typically, water services and electricity) do not necessarily have to be monopolies if they can be broken down into smaller segments, and yet not compromising on cost or technical efficiency. The important element is that the regulator must be strictly independent from either political or state-driven intervention.

So are the ideals of a truly free market conceivable in countries where corruption is rife and the influence of state is still overwhelmingly strong? There aren’t direct answers, but this much is true: whichever side of the ideological spectrum one is on, cronyism must be considered the common enemy, as it concentrates wealth in the favoured and deprives hundreds of other competing firms from growing, bumiputra or not.

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