Business-Government Collusion; E. C. Banfield

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 pre sumably works "against" business, goes hand-in-hand with special privileges and artificial protections "for" business. Third, the phenomenon of active and routine col lusion 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 Mr. Banfield is owner of Banfield Analytical Services in Westmont, Illinois. As an adjunct policy analystfor the Heartland Institute, he has testified before the National Association of In surance Commissioners, The Illinois General Assembly, and a U.S. Republican Hearing on healthcare reform.

83 nexus between the market sector and the government sector. All too often, busi nesses lobby government for special privi leges they would not have in a true, free market. What Is Pro-Business? Much political rhetoric over the past de cade 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 con servative "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 busi ness or an industry, usually at the expense of other people. The government creates some law or regulation that allows a busi84 THE FREEMAN • FEBRUARY 1995 ness 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 them selves-torn between a desire to be left alone and an appetite for special favors-are often unsure quite what they want from government. ,,1 Examples of Privilege Bailouts. Clear-cut examples of artificial, government-granted privileges include bail outs, 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 per petually propped up, regardless of their condition. For example, government offers "small businesses" subsidized loans at be low-market interest rates, with the taxpayer assuming the risk. When government assisted "smallbusiness investment com panies" fall, these "venture capital" firms simply declare bankruptcy before the gov ernment's Small Business Administration can file a claim on the assets. 2 Outright "disincentive" subsidies. An other clear example of privilege is subsidies in which an outright payment occurs. For example, agricultural corporations get ev ery kind of corporate subsidy imaginable, including dairy price supports, export enhancement programs, and payments for not growing certain crops. 3 Resource privileges. Other privileges in clude special deals for ranchers, oil compa nies, 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.4 Monopoly privileges. Another example of privilege is cable companies and utilities that get granted exclusive monopolies over their regions, using the law to outlaw sys tematically any competition.5 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 "com pensatory" protections and other favors. The administration "negotiated conces sions" for flat glass, durum wheat, home appliances, wine, peanuts, textiles, sugar, and citrus and vegetable interests, all "po litically sensitive industries" that needed "relief. ,,6 Large businesses have often supported labor, zoning, permit, safety, or other reg ulations designed to keep out low-cost com petitors, because the bigger firms were al ready 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 ~ntrants. Com panies lobby for standards which they can meet, but impose high costs on competi tors. ,,7 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 sell ing low-sulphur coal have rooted· for legis lation 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. 8 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 agricul tural company that dominates the ethanol BUSINESS-GOVERNMENT COLLUSION 85 market."9 ADM did no direct lobbying on the issue, but "didn't have to." Competing industry groups charge that ADM's influ ence was indirect, primarily through The Renewable Fuels Association, a trade group.10 It's routine. One insurance executive noted, "It's common in our industry: Large companies support legislation to drive out small competitors." 11 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 lobby ing 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 lobbyingefforts], even ifyou're a farmer. ,,12 The Harm to Others When the harm to consumers and taxpay ers 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 gov ernment. That is, the proper pro-business stance is "negative" (Le., the state should leave me alone). A "positive" stance (Le., the state should do me a favor) is improper. Those favors or privilegeswould not exist in a true free market without government in tervention. 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 slip perier 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 princk pIes. Some would argue that anybody who can get a break from burdensome govern ment 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 $1.00in 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 ·ac cepting a special tax break is "unethical."

A Wall Street Journal editorial, focusing on the' 'industrial subsidy game" played by state and local governments, recently tack led this tricky issue. "The cleanest line we can draw . . . is between enterprise that is subsidized and that which isn't." The edi torial faulted the city of Austin, Texas, for givinga tax break to Apple Computer onthe following grounds: "As long as ... locali ties go bidding for business with funds that must be raised from other taxpayers, then the objections of other citizens must be weighed" [Italics added].13 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 govern ment 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 privi leges or not, they seem increasingly unprag matic, even to policymakers. Some mayors of large cities abhor the idea "that politi86 THE FREEMAN • FEBRUARY 1995 cians can create jobs by handing out tem porary tax bribes to companies" to spur a city's economic activity.14 The Heartland Institute wrote' 'there is growing consensus among experts and the general public" that tax abatements and subsidies "are an un sound investment. ,,15 Businesses, too, are learning those tax breaks can backfire. A Michigan judge re cently barred General Motors Corporation from closing its Ypsilanti assembly plant, on the grounds that GM's acceptance of Mich igan's tax abatement program was "a prom issory estoppel," a contract or implied promise to keep the facility operating in exchange for relief on its taxes. 16 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 difficultyin defining priv ilege, we can say that regulation and privi lege are two sides of the same coin. And, to extend the analogy, performing the regula tion-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 regu late. 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 com plains 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 busi ness suffered harsh regulation but enjoyed the offsettingprivileges of deposit insurance and legal protection from competition. The system contained its inherent problems be cause the two were roughly balanced. The Depository Institutions Deregulation and Monetary Control Act of 1980 removed some of the industry's burdensome regula tions, yet it increased the privilege of de posit insurance, boosting coverage to $100,000per account from $40,000. Regu lation and privilege became unbalanced, so the industry abused the privilege of taxpay erbacked deposit insurance, and taxpayers got stuck for $170 billion.17 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 regula tion 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 associa tions. 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 playa polite, concil iatory 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 reg ulated industry rarely fights to defeat an entire measure. Instead, it focuses its re sources 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 proBUSINESS-GOVERNMENT COLLUSION 87 cess: Scrap all the regulations that serve as little more than tollgates for graft.,,18 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, busi nesses 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 con stantly revisit old issues to redefine what is illegaland what is not, for they wish at least to act legally. They ask government for "guidance," "flexibility," "no-action let ters, " 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-enforce ment," "comfort levels," or "safe har bors, " so they can proceed in their business with increased legal certainty, with clear and consistent definitions of the law.

Technical Input 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 coop eration abound in finance, such as insurance and banking, especially with regard to ac counting or actuarial matters. Regulations and laws written without industry input would otherwise be self-contradictory, in feasible, 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 officialswhy the new rules must be written very carefully. Government accepts input from business so it can say its enlightened, interactive, "give-and-take" process re sulted 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 gainingsome regulatory privileges or advan tages 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 lookingfor permission to rob or defraud people. They just want better defi nition of the laws, because they are so numerous, so comprehensive, and so per vasive. Businesses want legal confidence so they can· form expectations and plan ahead. The RevolvingDoor The people who participate in that pro cess can then pass through the "revolving door. " Businesspersons with expertise at dealingwith government on technical indus try 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 "reason able" and wants to get the regulation "right. " Regulators, with experience at dealing with industry executives, in tum find opportunities as corporate government relations directors or lobbyists in trade as sociations.19 The Game 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 influ ence 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 88 THE FREEMAN • FEBRUARY 1995 hostile and stubborn, unwilling to compro mise, unwilling to "play the game." Regu lators 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 peIforming a patriotic duty by resisting the arrogant and undeserved application of . . . law.' ,20 Still, a business or industry that shuns the very process that writes its industry's reg ulation would finditself 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 tanta mount 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 busi nesses use that access window to write regulations that harm their competitors un justly, or at consumers' expense, then they are abusing the process. Regulatory Capture The phenomenon of using the regulatory process to one's advantage is nothing new. Economists years ago labeled it "the cap ture 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 regu lated firms (who have "captured" them through the political process), not con sumers. 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].21 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 protec tions. Becker wrote: Corruption is common whenever big government infiltrates all facets of eco nomic life. In modern economies, profits often are determined more by government subsidies, taxes, and regulations than by traditional management or entrepreneur ial skills. Huge profits ride on whether companies win government contracts, get higher tariffs and quotas, receive subsi dies, have competition suppressed, or . . . have costly regulations suppressed.

Companies respond to the importance of government's role by striving to influ ence political decisions. It is often effec tive just to lobby politicians, and ... bribe officialsand politicians in return for government favors and profits.22 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 even tual demise, or to be free and responsible institutions. " Paul Weaver of the Hoover Institution, in a book review, summarized: "Many cor porations . . . 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 pol icies that make a lot of bigcompanies unable or unwilling to cope in a competitive world.,,23 A Needed Change in "Business Ethics"

Business firms don't seem to make much effort to separate themselves from the poBUSINESS-GOVERNMENT COLLUSION 89 litical process. Perhaps the growing number of socially responsible consumers and in vestors would flock to the products and stocks of firms that made a point of distanc ing themselves from all forms of business government collusion. Imagine the follow ing 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 for eign competitors to try to underprice us. We do not lobby for tariffs, quotas, or antidumping laws. We do not support the government's budget deficits: Our trea sury 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 perpet ual attempt to micromanage all of our busi ness 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 gamer 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. D 1. "The slings and arrows of outrageous fortune," The Economist, October 30, 1993, p. 25. 2. See, for example, Virginia I. Postrel, editorial, "Pop ulist Industrial Policy," Reason, January 1994,pp. 4,6; John R. Emshwiller, "How to Lose Federal Millions and Owe Noth ing," The Wall Street Journal, February 15, 1994,p. Bl; Jeanne Saddler, "Agency Demands Restrictions on SBIC Bankrupt cies," The Wall Street Journal, February 22, 1994, p. B2. 3. See, for example, "Grotesque: A Survey of Agricul ture," 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 Econo mist, March 6, 1993, p. 16. 5. Thomas W. Hazlett, "Who's Behind the Cable Scam," The Wall Street Journal March 30, 1990, p. AI0; and same author, "Why Your Cable Bill Is So High," The Wall Street Journal, September 24, 1993, p. AI0. 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. 8. Ibid. 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 Lobby ing," The Wall Street Journal, December 29, 1993, p. AI0.

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 Per suaders," Treasury and Risk Management, Summer 1993, p.21. 13. Review & Outlook, editorial, "Bite ofthe 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 Choke hold, "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 o/Economics and Management Science, Spring 1971; and James Q. Wilson, "The Politics of Regulation," in J.Q. Wilson (ed.), The Politics 0/ Regulation (New York: Basic Books, 1980). 22. Becker, loc. cit. 23. The Wall Street Journal, May 24, 1989.