Luigi Zingales teaches finance at the University of Chicago’s Booth School of Business and is the author of “A Capitalism for the People.” He argues that what those who oppose big business and those who oppose big government fail to perceive is that they are fighting the same enemy: crony capitalism. Big business could not survive without the protection it receives from government, and big government could not survive without the backing it receives from business. In 2013, I spoke with Zingales about the forces threatening American capitalism and what we can do about it.
Calvin Coolidge famously declared that the chief business of America is business. Was he wrong?
I don’t think he was wrong, but people don’t understand how we should achieve this. When you go to the Grand Canyon, there is a sign that says “Please don’t feed the animals.” It goes on to explain that precisely because you love animals, you need to make sure they are in an environment where they can keep hunting and acquiring food in natural ways so they can survive long term. I think the same logic applies to business. We need to tell Washington: please don’t feed the businesses. If you love business, you should want it to remain competitive in the normal marketplace without any government subsidies and market distortions, because those distortions end up hurting the very businesses you’re trying to help.
You argue that instead of being pro-business, we should be pro-market. What is the difference?
Both sides of the political spectrum want to portray themselves as pro-business. This means they want to subsidize and help existing businesses instead of thinking about how we can make the marketplace fairer, and the playing field more level for all. That’s what pro-market policies are all about. Businesses are always for free markets when they first enter an industry, but the moment they are established, they want to limit entry and build restrictions to make more profit. There is a danger when government gets involved in sanctioning these barriers to entry.
Americans have a tradition of protesting about social issues like abortion, gay marriage, and gun control. Why don’t we get more outraged over crony capitalism?
I grew up in Italy, so I’m naturally a conspiracy theorist. Attention is paid to these social issues precisely to distract from what is more fundamental.
In his book What’s the Matter with Kansas?, Thomas Frank argues that Republicans have perfected the art of using hot-button social issues to get people to vote against their economic self-interest. But it’s not just Republicans, is it?
The big issues like gay marriage and abortion that divide the two political parties hide the fact that both parties subsidize business. There is, in fact, a universal consensus between the establishments of both parties. You would be hard-pressed to find any discontinuity between, say, the policy that Hank Paulson used at Treasury and the one that Timothy Geithner used at Treasury.
Why is it that we usually only hear concerns about the power of big business from the left?
In part, the responsibility is on people who are most vocal in their support of capitalism. Because they love the free-market system, they mistakenly think they have to love big business and everything big business does. Actually, it should be the other way around: because we love the free-market system, we should be particularly severe on businesses that distort and desecrate the system. The only kind of criticism raised against the power of big business is from people on the extreme left— so much so that any criticism of big business is now immediately identified as being leftist. I don’t think this should be the case. Pro-market people should be just as outspoken about the distortion taking place in capitalism today.
Jeb Hensarling, who chairs the House Financial Services Committee, once described his economic philosophy in very similar terms, stating that he is not pro-business, but pro-free enterprise. Does he represent a new populism on the right, or is he just an outlier on the periphery?
I think he’s an outlier, but he’s a sign of something that is boiling underground. There is a huge potential in the United States today for a populist, pro-market movement.
To be fair, this is the same Jeb Hensarling who just took a bunch of Wall Street lobbyists to a posh ski resort for a vacation fundraiser last week.
And the danger is that arguing against crony capitalism can be a useful cover for other things. I try to be across-the-board in my criticisms. The problem is everywhere, and we need to ferret it out.
You write about the harm that lobbying does to the public good. But isn’t lobbying a case of “we have met the enemy, and he is us?” We only call it lobbying when the other guy does it. When I do it, I’m simply exercising my constitutional right to free speech.
There is no question that some lobbying is good, and that’s why it is protected by the Constitution. When lobbying is advocating a position, this is what democracy is about. The more transparent and widespread this process is, the better.
But lobbying has matured. Twenty years ago, a lot of lobbying was about how to get the government off your back, and as a libertarian, I am sympathetic to that. Today, however, it’s about how to get the government in your pocket.
But isn’t it completely rational for groups to protect their own self-interest by lobbying government?
When you lobby for your interests, you are maximizing your benefits, and what you are doing is exercising an optimal response. Nevertheless, this optimal response isn’t always right for the system as a whole. If everybody rushes the doors when there is a fire in the building, the optimal response for each individual is to run faster. But you know this is not a good thing to do. You need to bring a bit of order and have people exit the building in a proper way that can maximize the number of people who can be saved.
How have businesses responded to your call for a system of rules designed to benefit the system as a whole?
I sometimes feared that I would rub business executives the wrong way with such arguments, but I have received an enormous amount of support from the business community.
Don’t they just go back to their normal lobbying activity?
Yes, but they do not like it either. They feel they are in a rat race, and they want to get out. But unilateral disarmament is not a very smart strategy.
After the Great Crash of 1929, the Pecora investigation exposed the corruption of the big banks for all to see. Public outrage led directly led to the creation of the SEC and an entire regulatory system to make sure Wall Street was playing by a fair set of rules. In our rush to fix the economy, did we miss an opportunity to pass real financial reform?
President Obama had a different agenda when he took office. He was elected on the promise of health care reform, and he decided that this was his historic moment to pass it. Everything else, including the financial crisis, was given the second page. By the time he started to look at it more seriously, it was much more difficult to deal with. In March 2009, banks were on their knees. The president could have reshaped the financial services industry any way he wanted. I think that he did not have a clear idea how to do it, and the advice he got from Tim Geithner and Larry Summers went in the wrong direction.
I don’t think that the need for justice means we have to burn everything down, either. But we have gone to the opposite extreme of trying to cover everything up. This does a lot of damage to people’s perception of fairness, and ultimately leads to an erosion of support for free-market principles.
Why don’t we worry more about this loss of faith in free markets?
Because it cannot be measured properly. Our political system over-reacts to things that are measurable and under-reacts to things that are non-measurable. The value of the stock of capital is measured every day in the stock market, so politicians pay a lot of value to the stock market. Faith in free markets is not measured so precisely, so it tends to be ignored.
Does either political party have a better track record than the other when it comes to resisting crony capitalism, or are they simply in thrall to different interests?
I think they are equally in thrall.
Did repealing Glass-Steagall cause the financial crisis?
No, I don’t think we can blame the crisis directly on not having a separation between investment banking and commercial banking. At the time, I thought its repeal was a reasonable thing to do. Glass-Steagall was originally passed back in the 1930’s, and I felt that a lot of things had changed by 1999.
But you later became a fan of Glass-Steagall. Why the change of heart?
There were a few reasons. First of all, consider the attempt to separate proprietary trading from non-proprietary trading— something which now goes by the name The Volcker Rule. I realized how difficult it was to do it except by actually separating investment banking from commercial banking. We can argue whether this is the best response to the problems we saw during the crisis, but at least it is a definite response— and one that goes in the right direction. But the Volcker Rule, by itself, is unenforceable because it requires regulators to identify the intention of trade: whether a bank intends to trade for a client, or whether it intends to trade on its own account. In practice, this is extremely hard to determine.
You write that Glass-Steagall also prevented individual actors in the financial sector from joining forces.
Part of what kept the power of the financial industry at bay since the Great Depression was that it was divided. Commercial banks were pushing one way, and investment banks were pushing another way. As we know, competition benefits capitalism. In this case, competition, or conflicting interests, benefited voters and the system overall. But once the financial industry became consolidated, all participants could march together in the lobbying process, and they could basically get their way throughout. Such a concentration of power is bad for free markets.
Last month, the economy added 165,000 new jobs, and the unemployment rate dropped to 7.5%. The stock market now stands at record highs. Are we back? Is the recovery finally on safe ground?
I think we are on a slow path of recovery, but I’m much more worried about the underlying trend. If we look from 2000 to today, we’ve had some ups and downs, but we have a definite trend in reduction of employment— not necessarily higher unemployment, but a reduction of employment —especially among lower-educated people who seem to be increasingly marginalized. This is going to increase inequality and social tension in the long term.
A few months ago, a 28 year-old graduate student caught an Excel error in the work of two major economists which has called into question the entire argument that governments should cut debt to create economic growth. Are people justified in criticizing economists for presenting their models with the same certitude normally reserved for the physical sciences?
I actually see the Reinhart-Rogoff scandal as a great moment in economics. The fact that a 28 year-old graduate student at the University of Massachusetts can bring down a tenured professor at Harvard and a former chief economist at the IMF is an indication of how much of a science our discipline is. Even smart people make mistakes. It’s OK as long as those mistakes are uncovered, and uncovered quickly.
Do the corrections to Reinhart-Rogoff mean that we are too fixated on cutting spending and reducing deficits today?
I think the most important emphasis on cutting should be on cutting for the long term, not cutting in the short term. The more the economy recovers, the more that cutting in the short term can be good, but there’s no doubt that when you cut expenses the immediate impact is negative. Imagine I waste money by supporting some workers who don’t do anything, and I decide to fire them. Now, it will take some time for them to find new jobs. Remember: although they were producing nothing, the wages they received were reflected in GDP. So the immediate impact in cutting is a drop in recorded GDP. The bet that Germany and other European countries are championing right now is that the long-term effects of cutting will eventually prove to be good.
You argue that the complexity of regulations makes us more dependent on the lobbyists’ specialized knowledge, and that the purpose of complexity is often to hide loopholes which benefit specific industries. How much of this corruption is an inevitable byproduct of a legislative process that produces hundreds of new laws each year?
There is no doubt that there is too much production. Part of the reason I think we should limit the number of laws and simplify them is that it would make it more difficult for corruption to hide. In the shade, a lot of things take place. When you produce laws that are 2,000 pages long, even members of Congress don’t read them. The only ones who can really control them at that point are lobbyists.
Do you see anyone on the left or right today who you think understands the threat posed to our democracy by crony capitalism?
I was quite supportive of Paul Ryan’s plan last year, and I think he understands many of these issues. There are other people like him who understand the issues, but it’s not clear that they want to run with them. Part of the problem is that you’re going to implicate a lot of the establishment. Anyone who has a career in Washington will find it very difficult to turn around and dismiss the very system they are a part of.
To learn more about how we can restore the free-market system and recapture the genius of American prosperity, check out Luigi Zingales’ latest book, “A Capitalism for the People.”
Originally published on PolicyMic.