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OPINION

June 6, 2012, 6:44 p.m. ET

Crony Capitalism and the Crisis of the West

In Italy and Greece, the most talented don't get ahead. That's also increasingly true in the United States.
By LUIGI ZINGALES

As Greece sinks toward a financial abyssand Portugal, Italy and Spain sit on the edgecan we in the United States consider ourselves safe? Fundamental economic numbers offer little reassurance. At 8.6% of gross domestic product, the U.S. budget deficit is just under Greece's (9.1%) and equal to Spain's. U.S. debt, at 103% of GDP, is just below Portugal's which first asked for a European Union bailout in 2011and 58% larger than Spain's, which might soon need one. Yet Americans should be concerned for a deeper reason. High deficits, high debt and unsustainable entitlements are symptoms of a common disease infecting Southern Europe and the U.S. That's crony capitalism, a problem with which I, having lived in Italy, am unfortunately familiar. Cronyism has a long history in Italy, where historically the Catholic Church enjoyed tremendous influence. Popes and other members of the hierarchy wieldedand often abusedenormous power, including that of placing their children and friends in positions of influence, regardless of merit. A truly competitive market has no place for favoritism, but when one company or institution dominates a market, such practices become inevitable. In Italy today, even emergency-room doctors gain promotions on the basis of political affiliation. Instead of being told to study, young people are urged to "carry the bag" for powerful people in the hope of winning favors. Mothers push their daughters into the arms of the rich and powerful, seeing it as the only avenue of social promotion. The nation's talent-selection process is broken: One routinely finds highly intelligent people employed in menial jobs while mediocre people often hold distinguished positions. Once an incompetent appointee finds himself in a powerful position, he tends to hire only subordinates of equal or lower quality, since more talented people pose a threat to him. After a few years, a firm's human capital will become so eroded that it won't be able to compete without some form of protection. The more protection it can gain from government, the greater the scope of the cronyism, which in turn makes protection even more necessary. Crony capitalism creates a vicious circle. Between 2001 and 2011, Italian per capita GDP dropped 4%. A lowor in Italy's case, negativegrowth rate makes it difficult to meet basic social obligations. When growth is high, it's much easier to satisfy everyone without burdening future generations. But when the pie shrinks, the temptation to shift the burden onto someone else is irresistiblehence growing future entitlements and expanding budget deficits. During the 10 years of negative growth, the Italian debt-to-GDP ratio increased to 120% from 109%. The worst consequence of crony capitalism is political. The more a system is dominated by cronies, the more it

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Luigi Zingales: Crony Capitalism and the Crisis of the West - WSJ.com

http://online.wsj.com/article/SB10001424052702303665904577450071...

generates resentment. To maintain consensus, the insiders must distribute privileges and subsidiesand the more they dole out, the greater the demand becomes. Traditionally, the U.S. has enjoyed a relatively honest democracy and transparent form of capitalism, which encouraged robust economic growth and contained the hunger for entitlements. This is less and less true. The U.S. tax code is filled with loopholes and special exemptions. Political connections increasingly count more than innovative ideas; young entrepreneurs often learn to lobby before they learn how to run a business. Seven out of the 10 richest counties in the U.S. are in the suburbs of Washington, D.C., which produces little except rules and regulations. Even worse, the slow growth and decreased social mobility of the last decade have damaged the free market's reputation as a creator of prosperity. The hundreds of millions of dollars awarded for disastrous economic performancefrom Robert Rubin's salary as chairman of almost-bankrupt Citigroup to government loans for the actually bankrupt solar company Solyndrahave in turn weakened public belief in the system's fairness. For the U.S., the moment to act is now, before the cancer of crony capitalism metastasizes. The tax code needs an overhaul that eliminates special treatment and bans any form of corporate subsidystarting with too-bigto-fail banks. We must find ways to introduce more competition into sectors such as education and health care, while expanding economic opportunity for those at the lower end of the income spectrum. And we must curb the political power that large industry incumbents have over legislation. Not only does it distort legislation, it also forces new entrants to compete on lobbying instead of concentrating on making more innovative and cheaper products. It is not too late for the United States, but the clock is ticking. We have already begun to look like Italy. If we don't do something to stop that soon, we will end up like Greece. Mr. Zingales is a professor at the University of Chicago Booth School of Business and a contributing editor to City Journal. His book, "A Capitalism for the People: Recapturing the Lost Genius of American Prosperity," was published this week by Basic Books. A version of this article appeared June 7, 2012, on page A19 in the U.S. edition of The Wall Street Journal, with the headline: Crony Capitalism and the Crisis of the West.

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