“Man is the only animal that blushes – or needs to.” – Mark Twain
Since election day, the U.S. equity market, as measured by the S&P 500, has risen by just over 4%. Psychological exuberance and a risk-seeking mentality among investors, who are eager to leverage everything from cryptocurrencies to artificial intelligence themes are widespread. This one-sided herd mentality raises some concerns for me from a market sentiment perspective.
Nonetheless, it generally does not benefit investors to adopt a pessimistic view over significant time periods. Therefore, I am advising clients to stay the course and instead react to market developments rather than try to predict them. In other words, we will remain inactive until market direction signals otherwise.
One criticism leveled at the incoming President is his unapologetic tendency to reward those who are most loyal to him. This observation seems evident and uncontroversial, so I suggest we accept it for what it is.
Rent seeking is an economic concept that describes the process in which people seek to increase their own wealth without contributing to the creation of new wealth. Instead of producing goods or services, rent seekers attempt to gain economic benefits through manipulation of the economic environment.
Regardless of political stance, most people agree that rent-seeking behaviors pose challenges for long-term growth, trust, and sustainability. This is why I find it troubling that many businesspeople and politicians are spending an unusually large amount of time courting the incoming administration down at Mar-a-Lago in Palm Beach, Florida.
To unify the country and to get us firing on all cylinders, we might want to start things off by avoiding the appearance of cronyism.
The article below was recently published in The Economist magazine. I found it both timely and insightful.
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Cronyism is a problem. But not always an economic one
The Economist
December 5, 2024
When economists explain the financial crisis that hit the “tiger economies” of Indonesia, Malaysia and South Korea, among others, in 1997, some reach for the term “crony capitalism”. A cozy relationship between governments and firms distorted markets. The ensuing currency crises can be blamed on close ties between businesses, banks and politicians, rather than on panicky investors. Companies took excessive risks, safe in the knowledge that economic institutions were designed for their benefit. It was because of this rot that everything came tumbling down.
Today people worry that America is in for a spell of cronyism. After Donald Trump’s first term as president, Anne Krueger, an economist who coined the term “rent-seeking” 50 years ago, wrote that “Crony capitalism has taken root, and will...need to be weeded out.” Now, as Mr. Trump prepares to raise tariffs, “You’re going to find the halls of Washington really filled with special-interest groups and lobbyists,” Ken Griffin, founder of Citadel, a hedge fund, has warned. Markets appear to agree that personal connections to the new occupants of the White House are extremely valuable. The share prices of firms that have links with prominent supporters of Mr. Trump, such as Elon Musk, a businessman, and Peter Thiel, a venture capitalist, have shot up. On December 3rd PublicSquare, an online marketplace, announced that Donald Trump Jr, the president-elect’s son, would join its board—prompting the firm’s share price to more than double.
Trade wars, which Mr. Trump will stoke, certainly provide opportunities for cronyism. Ms. Krueger first examined “the political economy of the rent-seeking society”, as a paper in 1974 was titled, by looking at decisions by the Indian and Turkish governments to provide import licenses to specific companies. These policies did not just distort the market, they also forced firms to waste resources by competing for such licenses. A vicious circle then ensued: the public understood that profits were earned unjustly and thus demanded additional intervention to address the unfairness, creating more opportunities for rent-seeking. Other economists later pointed out that rent-seeking could also be expected to reduce innovation, as having to maneuver through a thicket of permits would dissuade new firms from entering the market.
Yet for all the theory, evidence of aggregate harm can be difficult to spot. Asia’s crony-capitalist economies were among the world’s fastest-growing in the 1970s and 1980s. Research by Raymond Fisman of Boston University finds that the share prices of Indonesian firms received a boost when one of the sons of President Suharto—who stole tens of billions of dollars—sat on their board, owing to the potential for corruption. At the same time, Suharto was known as “the father of development”, because of the average annual growth of 6.5% he oversaw during his three-decade reign. Although corrupt countries are generally poorer than less corrupt ones, it is unclear whether corruption causes poverty or both are indicators of a deeper pathology. Some economists even wonder if corruption “greases the wheels”: maybe those permits would never have been forthcoming without bribes.
Yuen Yuen Ang, a political scientist at Johns Hopkins University, has pointed out that all rich countries developed with flawed institutions. Cronyism and rapid industrialization existed side-by-side in America’s gilded age, which ran from the late 1870s to the late 1890s, as they do in China today. In both places, “corruption evolved away from thuggery and theft,” becoming what Ms. Ang terms “access money”, or payments to cultivate political ties. These are then often formalized and legalized, such as via campaign finance. Instead of being incentivized to slow down economic growth and accept payments to speed it up again, elites are incentivized to allow growth for fellow members of the club.
Recent research finds limited evidence that cronyism helps a country’s economy grow. But although it does not grease the wheels, it does not seem to be a disaster, either. Indeed, part of the reason it is difficult to discover a connection between cronyism and economic growth is because governments do not restrict markets just to favor their friends. They also frequently intervene in the name of public health, the environment and other worthy purposes. As Bruce Yandle of Clemson University has pointed out, both Baptists and bootleggers supported the prohibition of alcohol. What detractors called crony capitalism in Asia, supporters often labelled as industrial policy.
Rent-seeking by another name
Intention might matter in a court of law, but economics is more concerned with outcomes. Following Mr. Trump’s recent election victory, the prices of American solar stocks fell as investors gambled on an end to the Biden administration’s environmental subsidies. Although the purpose of such payments was to build domestic manufacturing capacity, rather than personal gain, the effect was similar: favored companies gained an advantage over their competitors, while the potential profits from aggressive lobbying rose. In this view, cronyism may be bad, but it is no worse than poorly designed industrial policy.
Should Americans therefore relax about what may be to come? Not quite. East Asia’s success did feature plenty of industrial policy, as well as straightforward corruption, but companies that were protected at home were at least exposed to cut-throat competition abroad. American industrial policy, which increasingly seeks to protect domestic companies from Chinese competition, faces no such market discipline. Mixing generous subsidies or steep tariffs with preferences for court favorites may have a more insidious effect on America’s economy than plain-old inefficient government spending would have done. And the full cost to American democracy, of course, may be greater still.
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Sincerely,
Justin Kobe, CFA
Founder, Portfolio Manager & Adviser
Pacificus Capital Management
A referral is the best compliment.
Feel free to forward this email to family and friends.
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