Our politicians have been quick to join the criticism. Last week David Cameron mooted granting extra powers to shareholders to restrain executive pay. Today he will give a speech on how to make capitalism more “inclusive”. Ed Miliband, meanwhile, has attacked “rip-off Britain” and backs forcing firms to consult workers on bosses’ pay levels.
There is a whiff of hypocrisy in some of these statements. Recent government initiatives include a plan to give top executives special access to ministers and a scheme to subsidise mortgages which will be run by the housebuilding industry.
Nevertheless, both leaders are correct in acknowledging the UK has a serious problem with “crony capitalism”. They are wrong, however, about the causes and solutions.
In fact, cronyism is quickly rooted out in a genuinely free economy. Companies that fail to incentivise success fall behind the competition. Cosy and complacent corporate cliques are outflanked by vigorous and innovative market entrants.
That is how markets are supposed to work. But Western economies have moved a very long way from free-market capitalism. It is not just that government spending now accounts for close to half of GDP; most sectors are also very heavily regulated.
For many firms, profits are more dependent on political favours than serving individual customers. Energy companies rely on rigged electricity markets for their reveunues from renewables; rail firms require operating subsidies; the defence industry needs government contracts, and so on. The banking sector is, of course, one of the most telling examples. Without the bailouts, many of the banks now being heavily criticised on pay would not exist.
This level of state involvement brings immense political risks to business. A new regulation, tax hike or subsidy cut can destroy profits or ruin investment plans. George Osborne’s raid on North Sea oil revenues is one recent example; the subsidy cut for the solar-power industry is another.
The incentives for business leaders to develop close relationships with politicians and regulators are therefore very strong. The returns from lobbying are often far higher than the returns from conventional business activity. Indeed, large corporate interests often successfully capture the policy process and use it to shut out competition or obtain favourable treatment. The losers are generally dispersed groups such as consumers and taxpayers, who are powerless to resist.
The answer is not, as politicians propose, to add more layers of regulation to control corporate behaviour. This will strengthen incentives for business leaders to get closer to government – an entirely counterproductive result.
Crony capitalism is inevitable given an intrusive regulatory state. It can only be stopped by removing the payoffs from special-interest lobbying – by a substantial reduction in political influence over business activity.
Richard Wellings is deputy editorial director at the Institute of Economic Affairs. www.iea.org.uk