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The Corrosion from Corruption

By Raymond Fisman·February 2
Boston University

The Issue:

The concern that people or corporations might try to influence those in power to pursue private goals at the expense of the public good crosses party lines. President Trump's calls to "Drain the Swamp" resonated with many of his supporters during the presidential election. Similarly, critics of the new administration have raised concerns over potential conflicts of interest that the President and several of his cabinet picks might have due to their business holdings and business relationships. While they are important,the costs of corruption go well beyond the value of bribes paid, lobbying efforts exerted, or ill-gotten profits obtained.
The most corrosive effects of corruption are the ways in which it affects who gets ahead, and the resultant impact on firms’ incentives and how the economy is organized.

The Facts:

  • Once it is clear that connections dictate success, firms devote resources to favor-seeking rather than developing valuable products and services. And the favors they seek – like monopolizing their industries – generally serve private rather than societal interests. Economist Anne Krueger, in an influential 1974 essay, coined the term, “rent-seeking society” to describe this unhappy — and unproductive — state of affairs, which prevails in many countries. Rents, in this view, are profits that are generated without creating anything of value to society.
  • Of course, Washington is hardly new to favor-seeking. Access is obtained through direct lobbying or campaign contributions. Researchers have, for example, documented the entirely unsurprising finding that lobbying is based on connections of former lawmakers and staffers, rather than area expertise in, say, healthcare or defense. The research shows that, when senators retire, revenues at the lobbying firms employing their ex-staffers drop substantially. If the ex-staffers were valuable for their expertise alone, one would not expect this to be the case.
  • The election of Donald Trump raised questions about two potential sources of rent-seeking that are relatively new to the American political landscape. The first pertains to the President's extensive portfolio of business holdings and the second to the very active way in which he has shown willingness to single out individual companies for praise or criticism regarding their business decisions. Both are cause for concern. But in both cases it is useful to consider the risks this behavior and policies present as compared to previous administrations, and also some points of comparison in other nations.
  • Businesses and governments that want to curry favor with a leader will pay inflated prices for goods and services provided by companies associated with that leader. Silvio Berlusconi, the media tycoon who has served as Prime Minister of Italy, exemplifies this. A recently published study found that Italian companies – particularly those in more heavily regulated industries – advertised more on the Berlusconi-owned TV network, and paid higher prices for those ads as well during periods when Berlusconi was in power. It is what the study’s authors call "indirect lobbying".
  • Corruption can also occur when a leader directly interferes with business decisions by specific companies.  If individual companies come to believe that their fortunes are tied to the whims and tastes of a leader, we are once again firmly in rent-seeking terrain. Companies may find that they need to spend time and resources in order to avoid being on the wrong end of a leader’s desired outcome rather than on product development or other business-related endeavors. Moreover, the resulting business decision might end up not being the most efficient or productive.

What this Means:

Trump's election has raised an unprecedented level of potential business conflicts of interest. Given the particular sources of Trump’s income – licensing his name; hospitality; etc – there are similarly many channels that are entirely legal through which parties may indirectly lobby for favorable treatment. Without diminishing the seriousness of Trump’s business conflicts, one should probably be circumspect in assessing whether it represents a marginally more toxic form of lobbying-as-usual, or is in fact something worse. Reasonable people can disagree on this question. On the other hand, Trump’s populist brand of industrial policy of direct involvement with specific companies --and associated rent-seeking-- is a particular worry; no company wants to be on the wrong side of a presidential tweet. The Carrier deal, in which then President-elect Trump announced that he had brokered an agreement that would save company jobs from being outsourced to Mexico in return for tax incentives, is one example. The immediate job gains may be beneficial, but the distortions these sorts of practices can lead to on a large scale can hamper growth, as other countries have learned.

Topics:

Corruption / Governance / Rent-Seeking
Written by The EconoFact Network. To contact with any questions or comments, please email contact@econofact.org.
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