Markets value competition, big business doesn’t, the difference matters.

Luigi Zingales writes, in the inaugural issue of National Affairs, about how Wall Street’s growing dependency on government threatens American capitalism. Traditionally, U.S. business doesn’t want government around, preferring a free, competitive market. Americans have supported our open market economy with its freedom of entry, widespread access to financial resources, and its level playing field. But now, concentrated power at the top, shared between government and corporate and financial powers out to stifle competition, mean America is developing what Zingales calls “crony capitalism,” the stogy political economy that prevails most everywhere else.

Here’s a summary of Zingales’ main points:

➢ Public support for capitalism is positively associated with the perception that hard work, not luck, determines success, and is negatively correlated to any perception of corruption.

➢ Instead under “crony capitalism”, the best way to make money is not to come up with brilliant ideas and work hard to implement them, it’s to cultivate a government connection.

➢ Only in America, democracy predated industrialization. The U.S. enacted regulations reducing the power of big business, developing anti-trust law—pro-market but often anti-business—fueled by an inquisitive press and a populist (but not anti-market) political movement. When Louis Brandeis attacked the money trust, he was trying to make markets work better, not stifle them.

➢ Until World War I, America had a tiny federal government, due in part to our facing no military threat. With government small and weak, people made money by starting a successful business. But as government grew, it became easier to make money by diverting public resources. Starting a business involves a lot of risk—getting a government contract is easier and safer.

➢ In countries with powerful Communist or socialist parties, pro-market and pro-business forces merged to fight the common enemy. Facing the prospect of nationalization (control of resources by a small political elite), “crony capitalism” (control of resources by a small business elite) seemed the lesser evil.

➢ Though American capitalism came closer than any other to the ideal of economic freedom and open competition, obscene wages and profits over the last 30 years have attracted our best talents to finance—with profound implications for government. The brightest undergraduates used to go into science, technology, law, and business. Now, it's finance. Four of the last six Treasury secretaries in fact were directly or indirectly linked to one financial firm: Goldman Sachs. By contrast, only one of the previous six Treasury secretaries even had a finance background.

➢ America’s financial industry is fragile because it relies on the sanctity of contracts and the rule of law. That sanctity cannot be preserved without broad popular support. Yet public mistrust of government, mistrust of bankers, concerns about wasting taxpayer dollars, and worries about rewarding Wall Street threaten a vicious cycle.

➢ To avoid being linked with the companies they are working to help, politicians encourage an assault on finance, which in turn scares off legitimate investors, no longer able to count on contracts and the rule of law. And this in turn forces troubled businesses to seek government assistance.

➢ This is the unhealthy cycle capitalism faces elsewhere. On one hand, entrepreneurs and financiers feel threatened by public hostility, and thus justified in seeking government privileges. On the other hand, ordinary citizens are outraged by the privileges entrepreneurs and financiers receive, which inflames even greater hostility.

We just saw how populism threatens both Democrats (big government) and Republicans (big business). Zingales suggests where Republicans should be—leaving the corporate elite to the Democrats, and channeling populist rage into political support for genuinely pro-market reforms. Republicans should seek to limit the financial industry’s power—any businesses’ power—and restore the fundamental principles that make capitalism ethical: freedom, meritocracy, a direct link between reward and effort, and willingness to ensure those who reap the gains also bear the losses. This would mean abandoning the notion that any firm is too big to fail, and adopting a pro-market, rather than pro-business, approach to our economy.