Capitalism, Cronyism, and Democracy.

Author:Hodgson, Geoffrey M.

Michael Munger and Mario Villarreal-Diaz promote an interesting and provocative thesis: Does capitalism have an inbuilt tendency toward cronyism? If so, as they point out, capitalism may be its own gravedigger after all, as Karl Marx, Joseph Schumpeter, and Karl Polanyi had previously pronounced, albeit using very different arguments.

Munger and Villarreal-Diaz argue that the very success of capitalism creates the temptation and potential for large businesses to lobby the state to protect their gains and their position from sustained market competition. As they note, Marx made a similar point. Leftists such as Guy Standing (2017) have lambasted such "corruption" within modern capitalism using a similar logic.

A second dimension to Munger and Villarreal-Diaz's argument concerns the role of democracy. They ask: "Does capitalism in a democracy always devolve into corporatist cronyism?" Noting the similar argument developed by Mancur Olson (1982), they write: "If prosperity enables democracy and the access to coercive powers of democracy allows businesses to concentrate their power and obtain state protection from competition, the result is cronyism.... In a democracy, the problem is particularly acute.... We are simply pointing out that allowing real democracy may doom real capitalism, just as many opponents of capitalism have argued."

I turn to Olson first. His argument has come under much critical scrutiny, although today his work is often unduly neglected. Olson (1982) argued that democracy can empower special-interest groups that increase institutional sclerosis. Jac Heckelman (2007) reviewed fifty-three attempts to test the effect of institutional sclerosis on economic growth. Some attempts were case studies; others involved quantitative comparisons. Fifty-seven percent of the studies supported Olson's institutional sclerosis hypothesis; 23 percent reported mixed support; and the remaining 20 percent were unsupportive. On balance, the theory concerning growth-retarding effects of institutional sclerosis had substantial but not universal support.

Institutional sclerosis is not the same as cronyism, although the mechanisms involved may be similar. The common thread in Olson's and Munger and Villarreal-Diaz's arguments is the idea that democracy enables the development and empowerment of interest groups that gain influence over politicians and the state machine.

It may be argued, however, that influence by powerful actors over the political process is possible in authoritarian as well as democratic regimes. Olsonian institutional sclerosis may happen, but it may not be confined to democracies. Does democracy help or hinder institutional sclerosis? Here the evidence is less clear.

For example, in a regression analysis of sixteen Organization for Economic Cooperation and Development countries with data from 1870 to 1987 (Hodgson 1996), I confirmed some Olsonian hypotheses, in particular the effect of major political disruptions in recasting institutions. But the analysis also found that democracy was positively rather than negatively associated with economic growth. Although the literature on the effects of democracy on economic growth gives mixed results, some studies report a positive correlation (Gerring et al. 2005; Rodrik and Wacziarg 2005; Acemoglu et al. 2014).

Cronyism and Democracy: Some Evidence

The only attempt to measure cronyism across leading economies of which I am aware is a "crony capitalism" index published by the Economist (2014). It covers twenty-three countries, including China, France, Germany, Japan, Russia, the United Kingdom, and the United States. As an index, it has come under some criticism, but apparently it is the best we have.

Figure 1 relates the Polity IV democracy index for 2013 (Center for Systemic Peace 2016) to the Economist's (2014) cronyism ranking. Note the weak positive correlation between the democracy index and the numerical value of the cronyism rank. Higher-ranked crony capitalisms have a lower numerical value, so this diagram shows a weak negative relationship between democracy and cronyism. The highest-ranked crony capitalisms shown in the figure are Russia, Malaysia, Ukraine, and Singapore, all of which have a democracy index of 6 or less. If there is a meaningful correlation at all, cronyism seems inversely related to democracy and economic development. (1)

Corruption and cronyism are not the same, but they are related, and they are likely to be positively correlated. Organizational corruption means breaking laws or other established rules in public or private institutions (Miller 2005; Hodgson and Jiang 2007). Figure 2 uses data from Transparency International (2016) on perceived levels of corruption in 158 countries. These data are related to the Polity IV data on levels of democracy for 2016. There is a slightly significant and mildly positive correlation between the corruption-perceptions index and democracy.

But note that Transparency International constructs its corruption-perceptions index so that the more corrupt countries have a lower score. Hence figure 2 shows a negative correlation between democracy and corruption. The five countries that are perceived as the most corrupt--Afghanistan, North Korea. Somalia, Sudan, and Syria--have democracy levels of 1, 0, 5, 0, and 0, respectively.

In sum, the evidence to hand does not support the contention that democratic regimes enable corruption or cronyism more than authoritarian states. There are several possible reasons why this may be so. Although perhaps facilitating corruption and cronyism in some ways, democracy allows more protest against them. Actual or possible public protest could influence politicians, who depend on popular votes. Democracy can also help to foster countervailing power, which can open up social orders, keep them more fluid, and keep ruling cliques in check (North...

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