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Douglas Holtz-Eakin Headshot

In Search of Crony Capitalism

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Government programs reshape the economy. Taxes are a cost, and people and firms reflexively adjust to reduce the price shock. Tax retail purchases, but exempt those purchased online, and the mix of sales will shift to the Internet. Tax work and work will suffer as women and men choose to pursue their non-market opportunities. Tax one type of business more than other, and firms will change their legal form. Perhaps most dramatically, tax luxury yachts and people stop buying yachts and shift their purchases elsewhere. Yacht builders suffer, yacht workers get laid off, while those in jewelry, and expensive cars benefit.

Tariffs work the same way, which is why the global trading community has been working ceaselessly to reduce tariff barriers and limit the degree to which they shape the patterns of global trade.

Regulations are another kind of tax. Regulate carbon emissions from power plants, and producers shift away from coal and use natural gas, nuclear, wind, solar and hydropower where they can. Mandate health insurance for full-time workers and employers will substitute part-timers where feasible.

The reality that government programs inevitably shift purchases, production, employment, and investment from sector-to-sector or firm-to-firm is not limited to the tax side of the ledger.

Purchase defense materials and manufacturers will focus on military products (and the reverse). Subsidize housing and people will buy homes, shifting away from landlords and new apartment building. Subsidize health insurance (and food stamps and unemployment and heating oil.....) and some people will take those benefits and not work to meet the same needs.

The economic lesson is clear: government programs inevitably create sectors, firms, and individuals who are bettered by a policy and corresponding sectors, firms, and individuals who are not. Winners and losers are part and parcel of policymaking.

This brings me to the debate over reauthorizing the Terrorism Risk Insurance Act (TRIA), which has been labeled "corporate welfare," and the Export-Import Bank (Ex-Im). Some critics refer to these programs as examples of "crony capitalism." What is it about these programs that merits such charges?

Do TRIA and Ex-Im affect the shape of economic activity? Of course. TRIA was intended to ensure that terrorism risk insurance was available at reasonable rates, thereby supporting existing commercial real estate businesses and new construction. Ex-Im serves to level the international playing field for U.S. exporters, thereby shifting the mix of commerce toward global sales and away from domestic purchases. Ex-Im offers four financial products -- direct loans, loan guarantees, working capital guarantees and export credit insurance -- in pursuit of its mission of boosting U.S. jobs through the financing of exports.

In the process there will be visible "winners" -- usually defined by those that are directly in contact with the program. However, just as the ultimate beneficiaries of repealing the luxury yacht tax were not the rich but rather the shipbuilders and boatyards, the ultimate beneficiaries for Ex-Im will be the workers, managers, and investors that finance export activity.

The fact that a program sends a payment to a corporation, or receives a tax payment or fee from a big business, simply cannot be prima facie evidence of crony capitalism.

Neither is public campaigning or lobbying. In a democracy both the winners and losers in a policy debate have every right to inform, educate, debate, and argue for the outcome they see as best - even if "best" is selfishly narrow. The vocal opponents of TRIA and Ex-Im are vivid examples of this right.

What about inappropriately cozy private relationships? There have been reports recently of Ex-Im employees accepting kickbacks and gifts. If true, that does constitute graft, malfeasance, and unlawful acts. It does not mean that the function of Ex-Im constitutes welfare or crony capitalism. For years, there have been concerns regarding tens of billions of dollars of inappropriate Medicare payments, some of which appear to stem from outright fraud. Does that make Medicare corporate welfare? There is a big difference between the design of a program and the integrity of its administration.

The key issue is whether the government purchase, transfer, tax, mandate or regulation needs to be in place at all. If private commerce can undertake the same activity in the same form, then the government program serves to use the power of the state to cement an economic relationship that might otherwise be subject to markets and competition. Reforms in 2010 required Ex-Im to ensure that its loans and guarantees assume commercial or political risk private financial institutions are unwilling or unable to bear. Nevertheless, concern about government overstepping its boundaries remain.

In the aftermath of the attacks of September 11, 2001 terrorism risk insurance disappeared from insurance markets and led to the creation of TRIA. During the financial crisis, numerous exporters found private credit unavailable and turned to Ex-Im for financing. Opponents of these programs sometimes argue these post-crisis episodes are misleading and that the programs are unneeded support. Proponents of reauthorization point to this (and other) evidence of the need for a continued government presence to pursue the policy goals.

How can the debate be settled? Politics and votes, of course. A pragmatic approach can apply to both TRIA and Ex-Im: reauthorize the programs with reforms to eliminate undesirable policy and to reduce the absolute scale of the programs. If as the programs are progressively scaled back the private sector experiences no trouble purchasing insurance or financing exports, then the data supports the notion that events have overcome the need for these activities. Alternatively, market stresses may emerge that both support the continuation of the programs and reveal important information about their necessary scale.

The debate over TRIA and Ex-Im has produced much sound and fury, and fewer hard facts and reasoned arguments. It certainly has not produced a compelling case for crony capitalism or corporate welfare.