Cronyism

INTRODUCTION

This book is about the birth of the corporatist state in America. It did not occur instantaneously or even within a couple of years; it spanned the eight decades from the collapse of the Jacksonian Democrats in 1849 to the pervasive dominance of Wall Street and big business before the Great Depression. The evolution of the government into a powerful cartelizer of the economy—finance, transportation, manufacturing, labor, food, and drugs—required multiple stages of myriad special interests persistently lobbying to reduce competitive market pressures. It required cronyism: government intervention that benefits special interests at the expense of the public interest.

American history books often mention how federal and state governments provided favors for businesses. In most cases, the literature justifies the granting of special privileges as benefiting the public and asserts that the politicians and interest groups were motivated to promote the public welfare. Some histories do identify these policies as examples of cronyism. However, they usually focus on specific cases. While this episodic approach is useful, the systematic and pervasive tendencies of cronyism and its effects remain hidden. Therefore, a general and integrated review of cronyism that ties specific actions to broader trends can help uncover the self-interested motivations of the actors who push for government privileges and the harmful consequences of their actions upon others.

In Cronyism: Liberty versus Power in Early America, 1607–1849, I used Murray Rothbard’s “Liberty versus Power” theory to analyze constitutions, central banking, tariffs, territorial expansion, and other special privileges in the years between the founding of Jamestown and the election of 1848. In that era there were multiple political movements and party organizations fighting for liberty and free-market policies against the forces of government power and favoritism.After 1849, the Liberty versus Power conditions no longer held. Since then, political parties have differentiated themselves only by which special interests and elites they reward with privileges. In the next era of American history, then, understanding the theory of special-interest-group politics becomes paramount.

Special-interest policies are embedded in government. The free market of consensual exchanges tends to result in mutually beneficial outcomes that grow the economic pie. The competitive profit-and-loss mechanism incentivizes individuals to allocate scarce resources toward producing goods that consumers value. Profits signal to businesses that consumers value the goods they purchase more than alternative goods that could have been produced; losses signal the opposite. However, activity by the government, the legitimated monopoly on force, does not benefit both producers and consumers; it creates winners and losers by redistributing and shrinking the economic pie. Political edicts, grounded in coercion, interfere with exchanges by taking goods away from certain individuals and giving them to others or declaring that only certain individuals may produce a good while others cannot. Government fiat, moreover, cannot allocate according to profit and loss because it is financed with taxation, and when the government possesses a monopoly on producing certain goods or services it does not face competition. Therefore, government intervention tends to harm the public while privileging select individuals and groups with favors that provide monetary or psychic gains. Potential beneficiaries have a vested interest in making sure that they and their allies reap their desired cronyism.

Rather than create things people desire on the unhampered market, a special interest or coalition of interests can lobby those who control the government machinery, the politicians up for reelection and insulated bureaucrats, for favors. Lobbying tactics include paying out bribes, hiring relatives, providing campaign contributions, holding closed-door meetings with officials, writing letters and other material, spreading public propaganda, and so on. When politicians and bureaucrats are convinced by lobbying, they introduce new bills, amend existing rules, or appoint new personnel to favorably administer the law. Interest groups’ main goal is to “capture” government policies by making sure officials help them and hurt their rivals. They accomplish this by offensively lobbying for their desired cronyism and defensively lobbying against policies proposed by contenders. It is a battle of money and influence, and to the victor belong the spoils. With special interests lining up at the government trough, cronyism never fails to increase, except when competing special interests produce political gridlock.

Some of the most economically destructive special-interest policies are those that hamper the competitive profit-and-loss mechanism by encouraging cartels and monopolies. On the free market, the ability of sellers to collude, or one seller acting alone, to restrict supply and raise prices is limited because participants can secretly break ranks and new sellers can enter the market. Cartels and monopolies are successful only when government-granted special privileges reduce the number of sellers, prohibit price cuts, or both. This cronyism can take the form of a direct intervention, such as a license, which blocks out certain producers in favor of the license holders. Or it can be indirect, such as through a reporting regulation or quality control that saddles compliance costs onto smaller firms with lower budgets and encourages them to exit the industry. In either case, thanks to the forced decrease in competitive pressure, the remaining sellers or seller can form a cartel or a monopoly. Unburdened by market competition, the privileged will cease innovating, lower quality, curtail supply, and hike prices. As the special privilege makes it harder for sellers to enter new lines of production and cut prices, the market’s ability to flexibly adjust to changing economic conditions diminishes. The losers are the competitors prevented from producing and the public who suffer from regimented production, deteriorating quality, fewer choices, and more expensive products.

Applying the theory of special-interest-group politics, my thesis is as follows: from 1849 to 1929 the general trend of cronyism was to establish government-sponsored cartels and monopolies. Contemporaries defined this system as corporatism and the government that administered it as the corporatist state. As the corporatist state developed, it restricted competition most prominently through regulatory commissions that raised barriers to entry, increased market share of select groups, reduced quality innovation, or mitigated price competition. The most influential special interests advocating the clamping down on competitive pressures were the nation’s big businesses—Wall Street banks, industry, railroads, and food and drug processors—who lobbied for their goal by allying with intellectuals eager for prestige and influence. However, due to the lobbying influence of rival bankers, smaller businesses, unions, merchants, and other groups, politicians enacted compromise regulatory commissions and other policies. It was only after the legislative process that big business captured the compromise policies by securing the appointment of personnel to interpret the legislative mandates in its favor. Due to changing personnel, laws, and rules, the corporatist state went through alternating periods of capture between various special interests until big business successfully established its desired network of mandated cartels and monopolies.

To prove my thesis, I describe the history of cronyism largely through business and economic history. My narrative focuses on these histories for two reasons: first, to show that big business and competing special-interest groups (e.g., smaller firms and labor organizations) were motivated to lobby for policies to benefit themselves; and second, to show that the special privileges they advocated were economically damaging to the public at large. Combined, the historical record demonstrates that government actions during this time were essentially a long train of privileged grants and forced redistributions.

Cronyism: Rise of the Corporatist State, 1849–1929 starts with the Compromise of 1850 and ends on the eve of the Great Depression. It comprises three parts.

The book opens with “Part I: The Plundering Generation, 1849–1861.” The possibility of the corporatist state emerged in the late 1840s after the collapse of the Jacksonian Democrats, the group so successful in dismantling the consolidating American System and its favoritism. The demise of the Jacksonians, the country’s last mass movement dedicated to libertarian reform, meant that it was only a matter of time before the disbursement of special-interest policies became the norm.

The Democrats could have prevented any corporatist state from arising; however, the divisive issue of expanding slavery into the western territories irrevocably wrecked their party. By the 1850s both the Whigs and Democrats favored their own special-interest land grants for a transcontinental railroad to the West Coast. But railroad promoters failed to acquire new land subsidies and other favors from either party because the slavery controversy created political gridlock. This contentious issue destroyed the political organizations and led to a new Republican Party that favored confining slavery to the South, granting land and monetary subsidies to northern transcontinental railroads, and shielding manufacturers with protective tariffs. The perceived threat from the Republicans after the election of 1860 convinced southern Democrats to secede, and the ensuing Civil War broke the political gridlock.

As explained in “Part II: The Great Barbecue, 1861–1897,” the foundations of the corporatist state could then be laid during the Civil War, when the one-party Republican rule implemented a neo–American System of transportation subsidies and monopolistic land grants, protective tariffs, and a centralized banking system. None of these laws enhanced public welfare or made the average person better off. Instead, they misallocated resources, raised prices, and limited consumer choice. Economic growth came in spite of, not because of, government intervention. The people who did gain were railroad promoters like the Big Four of California, producers in the National Association of Wool Manufacturers and the American Iron and Steel Association, and Jay Cooke & Co. and Wall Street bankers. They fed rapaciously at the government trough, the result of their handiwork.

The good times for emerging big businesses did not last. The subsidies dried up; the restrictions failed to prevent emerging forms of competition; and new railroads, shippers, smaller firms, unions, Chicago bankers, and others appeared on the scene to lobby for their own cronyism or co-opt the existing set of special privileges. New monopolization and cartelization attempts failed, including in the Interstate Commerce Commission (ICC), a regulatory agency proposed by the railroads to raise rates and mitigate competition in freight shipments.

By the 1890s, then, big business, led by the powerful Wall Street bank J. P. Morgan & Co., realized that it needed to change the plan. The government’s piecemeal erection of barriers to entry no longer worked; something far more grandiose was needed. That, of course, was for the government to enact corporatist policies that more explicitly and intensely controlled markets, to do what the ICC was supposed to do for the railroads and to do it better. To accomplish this goal, industrialists needed new regulatory commissions and executive departments, and especially the appointment of pro-big-business commissioners to run the agencies. Big businesses, like shippers, small firms, unions, and other rivals, began to forge partnerships with economists and other intellectuals, particularly those affiliated with the American Economic Association. It was a simple arrangement: convince the public that the commissions and departments were forward-looking, progressive reforms that helped people when the opposite was true, and in return enjoy positions of power as the official gatekeepers for the government and affiliated special interests.

If the Civil War led to the foundation of the corporatist state, the election of William McKinley in 1896 commenced the official construction. This building process is detailed in “Part III: The Corporatist Era, 1897–1929.” Each big-business group—Wall Street, corporations, railroads, and established food and drug interests—initiated lobbying efforts to convince government officials to devise regulatory agencies that carved up markets and restricted competition. By the close of the 1920s the groups had erected the corporatist state. J. P. Morgan & Co. and Kuhn, Loeb & Co. established the Federal Reserve System; US Steel and the National Civic Federation controlled the Department of Commerce and the Federal Trade Commission (FTC); the Association of Railway Executives enhanced the powers of the ICC in the Transportation Act of 1920; the Beef Trust obtained the Meat Inspection Act of 1906; and sugar, whiskey, and other food and drug producers strengthened the Bureau of Chemistry’s bureaucracy through the Pure Food and Drug Act of 1906. Affiliated economists, lawyers, and other members of the intellectual class obtained prestigious positions in government, in elite universities, or in big business–financed institutions like the Council on Foreign Relations and the National Bureau of Economic Research. In almost all cases Wall Street was not far behind, either as direct lobbyists or as financiers of the relevant concerns.

Paralleling industry’s cartelizing policies, unions strove to erect formidable barriers to kick lower-priced workers out of labor markets. The American Federation of Labor, the Big Four railroad unions, and other labor groups established a place for themselves in the corporatist state, lobbying for immigration restrictions and arbitration boards to move wage determination away from market forces. Several professions sought similar impediments through licensing boards, American Medical Association doctors standing out as the most prominent. In each economic sector, therefore, using the government to limit supply and raise prices was the name of the game.

Elites’ capture of the corporatist state was not automatically assured. For every big business advocating privileges there existed hostile smaller-sized firms, unions, politicians, or activists. This meant that whatever legislation Congress passed usually reflected a compromise among the different interests and only vaguely stated what the newly created agency or law was supposed to do. Thus, the potential for big businesses to capture the regulation still existed because they made sure to influence the personnel who executed and enforced the new rules. This followed the old strategy of the railroads, who in the 1880s had secured the favorable appointments of Thomas Cooley and other commissioners to the ICC.

Personnel indeed was policy, and big business secured favorable commissioners who enforced their favored corporatist regulations in the preferred manner. Most notably, Wall Street nominated Benjamin Strong to run the Federal Reserve Bank of New York. Strong used his position to turn the New York Fed into the most dominant of the regional central banks. He practiced expansionary monetary policy to promote foreign dollar reserves in a pseudo-gold standard and reverse Wall Street’s slipping grip on the balances of other banks. Thanks to Strong’s fourteen-year tenure, Wall Street exercised unparalleled dominance at the new central bank. This came at an enormous cost: the pro–New York monetary policy led to structural imbalances in real estate, high-tech sectors, and financial markets, laying the shaky foundations that caused the Great Depression.

Other big businesses were not far behind, though their capture of the relevant regulatory agencies fluctuated because their preferred commissioners did not rule for as long as, or as expertly as, Strong. This is seen clearly in industry. During the Taft presidency the Bureau of Corporations in the Department of Commerce and Labor ceased the preferential treatment that the Theodore Roosevelt administration had bestowed upon US Steel and other Morgan giants. After they successfully lobbied for a regulatory board, the Morgan corporations welcomed Edward Hurley to the FTC in early 1915. He established a liaison with big businesses over antitrust and other government interventions, promoted accounting standards that raised costs and reduced price competition, and supported American export cartels.

Optimism over the FTC quickly turned into disappointment once Hurley retired in early 1917 and the new commissioners favored inquisitive investigations, price controls, and antitrust lawsuits against large corporations. It was only in the 1920s that new appointments caused the FTC and the Department of Commerce to return to being dispensers of special privileges for large corporations. FTC commissioner William Humphrey proudly announced his pro-big-business dispensation and enforced monopolizing arrangements in domestic and foreign markets. Secretary of Commerce Herbert Hoover augmented his department’s network of subsidies and regulations, including new price information research, labor-management relations, and patent grants that businesses, like General Electric, exploited. Highly important side effects of this corporatism were the encouragement of small firms to consolidate into larger companies and making prices and wages less flexible. These consequences rigidified markets because they reduced competitive market forces and caused firms to be less responsive to changes in supply and demand.

Similar situations occurred in the railroad and meatpacking industries, though regulatory capture for them depended less on the specific personnel. The Pennsylvania Railroad lobbied for the Elkins Anti-Rebating Act of 1903 and the Hepburn Act of 1906 to reduce rate competition, but it and other railroads lost control of the ICC through the new Mann-Elkins Act of 1910 and commissioner appointments. To their horror, the ICC moved away from ending rate cuts to preventing rate increases, a disaster for railroad cartelists. Railroads and affiliated New York City banks recaptured the ICC after World War I, not so much because of favorable commissioner appointments (which did occur) but because the ICC bureaucracy caused it to enforce all the provisions of the Transportation Act ineffectively. The Chicago-based Beef Trust feasted on the Meat Inspection Act’s taxpayer-subsidized inspection and onerous compliance costs that disproportionately burdened smaller meatpackers until the Depression of 1920–1921 and technological change sharply eroded their gains and bankers took over Armour & Co.

The continual back and forth of the lobbying process, legislative revisions to existing laws, commissioner appointments, and so on rotated the winning and losing special interests. Yet in the end, big business won out and captured the commanding heights of the corporatist state. It was not a straightforward or linear path, but by the end of the 1920s business elites accomplished the cronyism they had aimed for since the 1890s: getting the government to thoroughly cartelize the economy for their gain.

The corporatist system was alive and kicking.

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Patrick Newman, Cronyism: Liberty versus Power in Early America, 1607–1849 (Auburn, AL: Mises Institute, 2021); Murray N. Rothbard, Conceived in Liberty, vols. 1–4 (Auburn, AL: Mises Institute, 2019); and Murray N. Rothbard, Conceived in Liberty, vol. 5, The New Republic, 1784–1791, ed. Patrick Newman (Auburn, AL: Mises Institute, 2019).