In public choice, a government failure is a counterpart to a market failure in which government regulatory action creates economic inefficiency. A government failure occurs if the costs of an intervention outweigh
its benefits. Government failure often arises from an attempt to solve
market failure. The idea of government failure is associated with the
policy argument that, even if particular markets may not meet the
standard conditions of perfect competition required to ensure social optimality, government intervention may make matters worse rather than better.
As with a market failure, government failure is not a failure to
bring a particular or favored solution into existence but is rather a
problem that prevents an efficient outcome. The problem to be solved
does not need to be market failure; governments may act to create
inefficiencies even when an efficient market solution is possible.
Government failure (by definition) does not occur when government
action creates winners and losers, making some people better-off and
others worse-off than they would be without governmental regulation. It
occurs only when governmental action creates an inefficient outcome,
where efficiency would otherwise exist. A defining feature of government
failure is where it would be possible for everyone to be better off (Pareto improvement) under a different regulatory environment.
Examples of government failure include regulatory capture and regulatory arbitrage.
Government failure may arise because of unanticipated consequences of a
government intervention, or because an inefficient outcome is more
politically feasible than a Pareto improvement to it. Government failure can be on both the demand side and the supply side. Demand-side failures include preference-revelation problems and the illogic of voting and collective behaviour. Supply-side failures largely result from principal–agent problem. Government failure may arise in any of three ways the government can
involve in an area of social and economic activity: provision, taxation
or subsidy and regulation.
History
The phrase "government failure" emerged as a term of art in the early
1960s with the rise of intellectual and political criticism of
government regulations. Building on the premise that the only legitimate
rationale for government regulation was market failure, some economists in public choice
developed new theories of how governments can make costly,
failure-prone, or ill-advised interventions into markets, creating worse
outcomes than the market failure itself.
Contemplation of an optimal system may provide techniques of
analysis that would otherwise have been missed and, in certain special
cases, it may go far to providing a solution. But in general its
influence has been pernicious. It has directed economists’ attention
away from the main question, which is how alternative arrangements will
actually work in practice. It has led economists to derive conclusions
for economic policy from a study of an abstract of a market situation.
It is no accident that in the literature...we find a category "market
failure" but no category "government failure." Until we realize that we
are choosing between social arrangements which are all more or less
failures, we are not likely to make much headway.
While a perfectly informed government might make an effort to reach
the social equilibrium via quality, quantity, price or market structure
regulation, it is difficult for the government to obtain necessary
information (such as production costs) to make right decisions. This
absence may then result in flawed quantity regulation when either too
much or too little of the good or service is produced, subsequently
creating either excess supply or excess demand. Imperfect information
can come in many forms including; Uncertainty, Vagueness, Incompleteness
and impreciseness. All creating flaws in government policy's and
therefore in turn creating inefficiencies within the economy.
Political interference
Political decisions may be made for short-term gain in response to interference by special interest groups. Interference can lead to market failures.
Political self-interest
The self-interests of a politician may undermine fair governance.
This could look like an inappropriate allocation of funds or time.
Public funds could be pushed to influence voters or time could be
allocated to pursue personal inequalities instead of actual market
failures. When politicians prioritize their self-interests over their
constituents' needs, they risk alienating the very voters who supported
them. This erosion of public trust not only diminishes their popularity
but also undermines the effectiveness of governance. Ultimately, such
self-serving behavior detracts from addressing critical societal issues,
leaving citizens disillusioned and the country vulnerable.
Policy myopia
Another cause of the government failure, as many critics of
government intervention claim, is that politicians tend to look for
short term fixes with instant and visible results that do not have to
last, to difficult economic problems rather than making thorough
analysis for solving long-term solutions.
Government intervention and evasion
It is believed that when a government tries to levy higher taxes on goods such as alcohol, also called de-merit goods, it can lead to increase attempts of illegal activities as tax avoidance, tax evasion or development of grey markets,
people could try to sell goods with no taxes. Also legalizing and
taxing some drugs may arise in a quick expansion of the supply of drugs,
which can lead to overconsumption, which can mean a decrease in welfare.
Government subsidies may lead to excess demand, which can be
solved in two ways. Either the government chooses to meet all the
demand, leading to higher consumption than socially efficient or if it
knows the socially efficient amount, it can decide who gets how much of
this quantity, a goal accomplished either through queuing and
waiting-lists or through delegating the decisions to bureaucrats. Both
solutions are inefficient, queueing first meets the demand of people at
the front of the queue, which might not be the ones who need or want the
product or service the most, but rather the luckiest or the ones with
the right connections. Delegating the decisions to bureaucrats leads to
problems with human factor and personal interests.
High administrative and enforcement costs
Market failure can occur when the costs of the project outweigh the
benefits. Costs that are included are; Tax collection through government
departments, law enforcement and policy creation. All these costs
allocations are quite broad however a lot of people are required to run a
secure and efficient system. Cost in the system are classified as a
credence-costs as the buyer cannot tell the quantity bought even after
buying them. This means that Administration and enforcement costs for a
project can be over or under assumed and therefore a market failure can
therefore be dismissed easily or over analyzed (however benefits can
also be credence-benefits).
Regulatory capture
Regulatory capture
is a problem which occurs whilst trying to implement regulations in
selected industry. As government regulators usually have to meet with
the industry representatives, they tend to form a personal relationship,
which may lead them to be more sympathetic towards requirements and
needs of given industry, subsequently making the regulations more
favourable towards the producers rather than the society.
Examples
Economic crowding out
Crowding out is when the government over corrects the market failure
leading to the displacement of the private sector investment. This
involves an excess amount of spending in the public sector, excess
increase in interest rates or excess increase in taxes all of which will
decrease the public sectors borrowing demand from banks. This whole
situation forces inefficiencies in the private sector and therefore
shrinks, causing a market failure from a government failure.
Regulatory
Regulatory arbitrage
is a regulated institution's taking advantage of the difference between
its real (or economic) risk and the regulatory position.
Regulatory capture is the co-opting of regulatory agencies by members of or the entire regulated industry. Rent seeking and rational ignorance
are two of the mechanisms which allow this to happen. Rent extraction
positively correlates with government size even in stable democracies
with high income, robust rule of law mechanisms, transparency, and media
freedom.
Regulatory risk is the risk faced by private-sector firms that regulatory changes will hurt their business.
Distortion of markets
Taxation can lead to market distortion.
They can artificially change prices thus distorting markets and disturb
the way markets allocate scarce resources. Also, taxes can give people
incentive to evade them, which is illegal. Minimum price can also result
in markets’ distortion (i.e. alcohol, tobacco). Consumer would spend
more on harmful goods, therefore less of their income will be spent on
beneficial goods. Subsidies can also lead to misuse of scarce resources
as they can help inefficient enterprises by protecting them from free
market forces.
Price floors and price ceilings can also lead to social inefficiencies or other negative consequences. If price floors, such as minimum wage, are set above the market equilibrium price, they lead to shortage in supply, in case of minimum wage to a higher unemployment. Similarly the price ceilings, if set under the market equilibrium price, lead to shortage in supply. Rent ceiling, for example may then lead to shortage in accommodation. Other problems often arise as consequences of these interventions. Black market
of labor and higher unemployment among uneducated and poor are possible
consequences of minimum wage while deterioration of residential
buildings might be caused by rent ceiling and subsequent lack of
incentive for landlords to provide the best services possible.
State monopolies
Most government providers operate as monopolies
(e.g. post offices). Their status is sometimes guaranteed by the
government, protecting them from potential competition. Furthermore, as
opposed to private monopolies, the threat of bankruptcy is eliminated,
as these companies are backed by government money. The companies are
thus not facing many efficiency pressures which would push them towards
cost minimisation - causing a social inefficiency.
There are still some existing efficiency pressures on state
monopoly managers. They mostly come from the possibility of their
political masters being voted out of office. These pressures are however
unlikely to be as effective as market pressures, the reasons being that
the elections are held quite infrequently and even their results are
often fairly independent on the efficiency of state monopolies.
Corruption
Corruption is the illegitimate use of public power to benefit a private interest. This erodes public trust.
EU Fisheries Policy
A leading example of governmental failure can be seen with the consequences of the European Union's Common Fisheries Policy
(CFP). Set up to counteract a concern of balancing natural marine
resources with commercial profiteering, the CFP has in turn created
political upheaval.
Overcoming government failure
When a country gets into this kind of complicated situation it is not
possible to reverse it right away. However, there are some arrangements
that the government could do, to try to overcome it step by step. For example:
The government could assign itself some future goals, and also try to fulfil them
Competitive Tendering – making good offers to private and public sector which may arise on into competition between them, which is good for moving forward
Public & Private Partnerships
– involving private professional to make decisions to cut less
necessary costs or to help to make some decisions. One of the key steps
can also be to delegate the power and decisions, which may release the
pressure from the government and help it to concentrate on more
important cases
The concept aims to reduce a possible current account deficit or reach a current account surplus, and it includes measures aimed at accumulating monetary reserves by a positive balance of trade, especially of finished goods. Historically, such policies may have contributed to war and motivated colonial expansion. Mercantilist theory varies in sophistication from one writer to another and has evolved over time.
Mercantilism promotes government regulation of a nation's economy
for the purpose of augmenting and bolstering state power at the expense
of rival national powers. High tariffs, especially on manufactured goods, were almost universally a feature of mercantilist policy. Before it fell into decline, mercantilism was dominant in modernized
parts of Europe and some areas in Africa from the 16th to the 19th
centuries, a period of proto-industrialization. Some commentators argue that it is still practised in the economies of industrializing countries in the form of economic interventionism.
Mercantilism became the dominant school of economic thought in Europe throughout the late Renaissance and the early modern period (from the 15th to the 18th centuries) before advent of Classical liberalism. Evidence of mercantilistic practices appeared in early modern Venice, Genoa, and Pisa regarding control of the Mediterranean trade in bullion. However, the empiricism of the Renaissance,
which first began to quantify large-scale trade accurately, marked the
beginning of mercantilism as a codified school of economic theories. The Italian economist and mercantilist Antonio Serra is considered to have written one of the first treatises on political economy in his 1613 work, A Short Treatise on the Wealth and Poverty of Nations.
Mercantilism, in its simplest form, is all about bullionism, or
the theory that a nation's wealth is measured in terms of how much
precious metal, particularly gold and silver, it possesses. Mercantilist
authors were concerned with the movement of money, however, more than
with the hoarding of it. They felt that money needed to move through the
economy to induce trade and economic activity, a concept different from
that of simply amassing wealth. This focus on money's role,
specifically precious metals, mirrors modern discussions of the money
supply and its implications for economic growth, i.e., how money supply
expansion can stimulate economic activity. However, with the advent of
fiat money (money not backed by a physical commodity) and floating
exchange rates, the importance of specie (gold and silver) in economic
systems has diminished. Progressively, the focus shifted from the
handling of money to the implementation of industrial policies that
placed greater economic goals, e.g., stimulating general prosperity and
supporting technological and industrial advancement, above the financing
of war.
England began the first large-scale and integrative approach to mercantilism during the Elizabethan Era (1558–1603). An early statement on national balance of trade appeared in Discourse of the Common Wealth of this Realm of England,
1549: "We must always take heed that we buy no more from strangers than
we sell them, for so should we impoverish ourselves and enrich them." The period featured various but often disjointed efforts by the court of Queen Elizabeth I
(r. 1558–1603) to develop a naval and merchant fleet capable of
challenging the Spanish stranglehold on trade and of expanding the
growth of bullion at home. Queen Elizabeth promoted trade and navigation
acts in Parliament and issued orders to her navy for the protection and
promotion of English shipping. The first Navigation Acts regulating trade were passed by Parliament in 1651 and 1652, during the English Commonwealth.
Authors noted most for establishing the English mercantilist system include Gerard de Malynes (fl. 1585–1641) and Thomas Mun (1571–1641), who first articulated the Elizabethan system (England's Treasure by Foreign Trade or the Balance of Foreign Trade is the Rule of Our Treasure), which Josiah Child (c. 1630/31–1699) then developed further.
Numerous French authors helped cement French policy around statist mercantilism in the 17th century, as King Louis XIV (reigned 1643–1715) followed the guidance of Jean Baptiste Colbert, his Controller-General of Finances from 1665 to 1683 who revised the tariff system and expanded industrial policy. Colbertism
was based on the principle that the state should rule in the economic
realm as it did in the diplomatic, and that the interests of the state
as identified by the king were superior to those of merchants and of
everyone else. Mercantilist economic policies aimed to build up the
state, especially in an age of incessant warfare, and theorists charged
the state with looking for ways to strengthen the economy and to weaken
foreign adversaries.
In Europe, academic belief in mercantilism began to fade in the late 18th century after the East India Company annexed Mughal Bengal, a major trading nation, and the establishment of British India through the activities of the East India Company, in light of the arguments of Adam Smith (1723–1790) and of the classical economists. French economic policy liberalized greatly under Napoleon (in power from 1799 to 1814/1815). The British Parliament's repeal of the Corn Laws under Robert Peel in 1846 symbolized the emergence of free trade as an alternative system.
Theory
Most of the European economists who wrote between 1500 and 1750 are
today generally described as mercantilists; this term was initially used
solely by critics, such as Mirabeau and Smith, but historians proved
quick to adopt it. Originally the standard English term was "mercantile
system". The word "mercantilism" came into English from German in the early-19th century.
The bulk of what is commonly called "mercantilist literature" appeared in the 1620s in Great Britain. Smith saw the English merchant Thomas Mun (1571–1641) as a major creator of the mercantile system, especially in his posthumously published Treasure by Foreign Trade (1664), which Smith considered the archetype or manifesto of the movement. Perhaps the last major mercantilist work was James Steuart's Principles of Political Economy, published in 1767.
Mercantilist literature also extended beyond England. Italy and
France produced noted writers of mercantilist themes, including Italy's Giovanni Botero (1544–1617) and Antonio Serra (fl. 16th–17th centuries) and, in France, Jean Bodin and Jean-Baptiste Colbert.
Themes also existed in writers from the German historical school from
List, as well as followers of the American and British systems of
free-trade, thus stretching the system into the 19th century. However,
many British writers, including Mun and Edward Misselden,
were merchants, while many of the writers from other countries were
public officials. Beyond mercantilism as a way of understanding the
wealth and power of nations, Mun and Misselden are noted for their
viewpoints on a wide range of economic matters.
The Austrian lawyer and scholar Philipp Wilhelm von Hornick, one of the pioneers of cameralism, detailed a nine-point program of what he deemed effective national economy in his Austria Over All, If She Only Will of 1684, which comprehensively sums up the tenets of mercantilism:
That every little bit of a country's soil be utilized for agriculture, mining or manufacturing.
That all raw materials found in a country be used in domestic
manufacture, since finished goods have a higher value than raw
materials.
That a large, working population be encouraged.
That all exports of gold and silver be prohibited and all domestic money be kept in circulation.
That all imports of foreign goods be discouraged as much as possible.
That where certain imports are indispensable they be obtained at
first hand, in exchange for other domestic goods instead of gold and
silver.
That as much as possible, imports be confined to raw materials that can be finished [in the home country].
That opportunities be constantly sought for selling a country's
surplus manufactures to foreigners, so far as necessary, for gold and
silver.
That no importation be allowed if such goods are sufficiently and suitably supplied at home.
Other than Von Hornick, there were no mercantilist writers presenting an overarching scheme for the ideal economy, as Adam Smith would later do for classical economics. Rather, each mercantilist writer tended to focus on a single area of the economy. Only later did non-mercantilist scholars integrate these "diverse"
ideas into what they called mercantilism. Some scholars thus reject the
idea of mercantilism completely, arguing that it gives "a false unity to
disparate events". Smith saw the mercantile system as an enormous
conspiracy by manufacturers and merchants against consumers, a view that
has led some authors, especially Robert E. Ekelund and Robert D.
Tollison, to call mercantilism "a rent-seeking society". To a certain extent, mercantilist doctrine itself made a general theory of economics impossible. Mercantilists viewed the economic system as a zero-sum game, in which any gain by one party required a loss by another. Thus, any system of policies that benefited one group would by
definition harm the other, and there was no possibility of economics
being used to maximize the commonwealth, or common good. Mercantilists' writings were also generally created to rationalize
particular practices rather than as investigations into the best
policies.
Mercantilist domestic policy was more fragmented than its trade
policy. While Adam Smith portrayed mercantilism as supportive of strict
controls over the economy, many mercantilists disagreed. The early
modern era was one of letters patent and government-imposed monopolies;
some mercantilists supported these, but others acknowledged the
corruption and inefficiency of such systems. Many mercantilists also
realized that the inevitable results of quotas and price ceilings were black markets. One notion that mercantilists widely agreed upon was the need for economic oppression of the working population; laborers and farmers were to live at the "margins of subsistence". The goal was to maximize production, with no concern for consumption. Extra money, free time, and education for the lower classes were seen to inevitably lead to vice and laziness, and would result in harm to the economy.
The mercantilists saw a large population as a form of wealth that made possible the development of bigger markets and armies. Opposite to mercantilism was the doctrine of physiocracy,
which predicted that mankind would outgrow its resources. The idea of
mercantilism was to protect the markets as well as maintain agriculture
and those who were dependent upon it.
Policies
Mercantilist ideas were the dominant economic ideology of all of
Europe in the early modern period, and most states embraced it to a
certain degree. Mercantilism was centred on England and France, and it
was in these states that mercantilist policies were most often enacted.
The United States, a former British colony, has also employed
mercantilist policies at times in its economic history.
French finance minister and mercantilist Jean-Baptiste Colbert served for over 20 years.
Mercantilism arose in France in the early 16th century soon after the
monarchy had become the dominant force in French politics. In 1539, an
important decree banned the import of woolen goods from Spain and some parts of Flanders. The next year, a number of restrictions were imposed on the export of bullion.
Over the rest of the 16th century, further protectionist measures
were introduced. The height of French mercantilism is closely
associated with Jean-Baptiste Colbert, finance minister for 22 years in the 17th century, to the extent that French mercantilism is sometimes called Colbertism.
Under Colbert, the French government became deeply involved in the
economy in order to increase exports. Protectionist policies were
enacted that limited imports and favored exports. Industries were
organized into guilds and monopolies, and production was regulated by
the state through a series of more than one thousand directives
outlining how different products should be produced.
To encourage industry, foreign artisans and craftsmen were
imported. Colbert also worked to decrease internal barriers to trade,
reducing internal tariffs and building an extensive network of roads and
canals. Colbert's policies were quite successful, and France's
industrial output and the economy grew considerably during this period,
as France became the dominant European power. He was less successful in
turning France into a major trading power, and Britain and the Dutch
Republic remained supreme in this field.
France imposed its mercantilist philosophy on its colonies in North America, especially New France.
It sought to derive the maximum material benefit from the colony, for
the homeland, with a minimum of colonial investment in the colony
itself. The ideology was embodied in New France through the
establishment under Royal Charter of a number of corporate trading
monopolies including La Compagnie des Marchands, which operated from
1613 to 1621, and the Compagnie de Montmorency, from that date until
1627. It was in turn replaced by La Compagnie des Cent-Associés,
created in 1627 by King Louis XIII, and the Communauté des habitants in
1643. These were the first corporations to operate in what is now
Canada.
In England, mercantilism reached its peak during the Long Parliament government (1640–60). Mercantilist policies were also embraced throughout much of the Tudor and Stuart periods, with Robert Walpole being another major proponent. In Britain, government control over the domestic economy was far less extensive than on the Continent, limited by common law and the steadily increasing power of Parliament. Government-controlled monopolies were common, especially before the English Civil War, but were often controversial.
The Anglo-Dutch Wars were fought between the English and the Dutch for control over the seas and trade routes.
With respect to its colonies, British mercantilism meant that the
government and the merchants became partners with the goal of increasing
political power and private wealth, to the exclusion of other European
powers. The government protected its merchants—and kept foreign ones
out—through trade barriers, regulations, and subsidies to domestic
industries in order to maximize exports from and minimize imports to the
realm. The government had to fight smuggling, which became a favourite
American technique in the 18th century to circumvent the restrictions on
trading with the French, Spanish, or Dutch. The goal of mercantilism
was to run trade surpluses to benefit the government. The government
took its share through duties and taxes, with the remainder going to
merchants in Britain. The government spent much of its revenue on the Royal Navy, which both protected the colonies of Britain but was vital in capturing the colonies of other European powers.
British mercantilist writers were themselves divided on whether
domestic controls were necessary. British mercantilism thus mainly took
the form of efforts to control trade. A wide array of regulations were
put in place to encourage exports and discourage imports. Tariffs were
placed on imports and bounties given for exports, and the export of some
raw materials was banned completely. The Navigation Acts removed foreign merchants from being involved England's domestic trade. British policies in their American colonies led to friction with the inhabitants of the Thirteen Colonies,
and mercantilist policies (such as forbidding trade with other European
powers and enforcing bans on smuggling) were a major irritant leading
to the American Revolution.
Mercantilism taught that trade was a zero-sum game, with one
country's gain equivalent to a loss sustained by the trading partner.
Some have argued that mercantilist policies had a positive impact on
Britain, helping to transform the nation into the world's dominant
trading power and a global hegemon. One domestic policy that had a lasting impact was the conversion of
"wastelands" to agricultural use. Mercantilists believed that to
maximize a nation's power, all land and resources had to be used to
their highest and best use, and this era thus saw projects like the draining of The Fens.
The American School of economics dominated United States national policies from the time of the American Civil War until the mid-20th century.It is closely related to mercantilism, and it can be seen as contrary to classical economics. It consisted of these three core policies:
Protecting industry through selective high tariffs (especially 1861–1932) and through subsidies (especially 1932–1970).
Government investments in infrastructure creating targeted internal improvements (especially in transportation).
A national bank with policies that promote the growth of productive enterprises rather than speculation.
Other countries
Mercantilism helped create trade patterns such as the triangular trade in the North Atlantic, in which raw materials were imported to the mother country and then processed and redistributed to other colonies.
The other nations of Europe also embraced mercantilism to varying
degrees. The Netherlands, which had become the financial centre of
Europe by being its most efficient trader, had little interest in seeing
trade restricted and adopted few mercantilist policies. Mercantilism
became prominent in Central Europe and Scandinavia after the Thirty Years' War (1618–48), with Christina of Sweden, Jacob Kettler of Courland, and Christian IV of Denmark being notable proponents.
The Habsburg Holy Roman Emperors
had long been interested in mercantilist policies, but the vast and
decentralized nature of their empire made implementing such notions
difficult. Some constituent states of the empire did embrace
mercantilism, most notably Prussia, which under Frederick the Great had perhaps the most rigidly controlled economy in Europe.
Spain benefited from mercantilism early on as it brought a large
amount of precious metals such as gold and silver into their treasury by
way of the new world. In the long run, Spain's economy collapsed as it
was unable to adjust to the inflation that came with the large influx of
bullion. Heavy intervention from the crown put crippling laws for the
protection of Spanish goods and services. Mercantilist protectionist
policy in Spain caused the long-run failure of the Castilian textile
industry as the efficiency severely dropped off with each passing year
due to the production being held at a specific level. Spain's heavily
protected industries led to famines as much of its agricultural land was
required to be used for sheep instead of grain. Much of their grain was
imported from the Baltic region of Europe which caused a shortage of
food in the inner regions of Spain. Spain limiting the trade of their
colonies is one of the causes that led to the separation of the Dutch from the Spanish Empire. The culmination of all of these policies led to Spain defaulting in 1557, 1575, and 1596.
During the economic collapse of the 17th century, Spain had
little coherent economic policy, but French mercantilist policies were
imported by Philip V with some success. Ottoman Grand Vizier Kemankeş Kara Mustafa Pasha also followed some mercantilist financial policies during the reign of Ibrahim I. According to the historian Alex M. Feldman,Russia under Peter I (Peter the Great) pursued mercantilism based on similarities with concurrent Spanish mercantilism and older models of political economy derived from the Byzantine economy.
Wars and imperialism
Mercantilism was the economic version of warfare backed up by the
state apparatus, and was well suited to an era of military warfare. If authorities viewed the level of world trade as fixed, it followed
that the only way to increase a polity's trade was to take it from
another. A number of wars, most notably the four Anglo-Dutch Wars (from 1652 to 1784) and the Franco-Dutch Wars (as from 1672 to 1678), can be linked directly to mercantilist theories. Most wars had other causes but they reinforced mercantilism by clearly
defining the enemy, and justified damage to the enemy's economy.
Mercantilism fueled the imperialism
of this era, as many nations expended significant effort to conquer new
colonies that would be sources of gold (as in Mexico) or sugar (as in
the West Indies), as well as becoming exclusive markets. European power
spread around the globe, often under the aegis of companies with
government-guaranteed monopolies in certain defined geographical
regions, such as the Dutch East India Company or the Hudson's Bay Company (operating in present-day Canada).
With the establishment of overseas colonies
by European powers, especially from the 17th century, mercantile theory
gained a new and wider significance, in which its aim and ideal became
both national and imperialistic.
The connection between Marxist theory and mercantilism has been explored by Marxist economist and sociologist Giovanni Arrighi (1937-2009), who analyzed mercantilism as having three components: "settler colonialism, capitalist slavery, and economic nationalism", and further noted that slavery was "partly a condition and partly a result of the success of settler colonialism."
In the French economy, the triangular trade method was integral in the continuation of mercantilism throughout the 17th and 18th centuries. In order to maximize exports and minimize imports, France worked on a
strict Atlantic route: France, to Africa, to the Americas and then back
to France. By bringing African slaves to labor in the New World, their labor value
increased, and France capitalized upon the market resources produced by
slave labor.
Mercantilism as a weapon has continued to be used by countries
through the 21st century by way of modern tariffs, as it puts smaller
economies in a position where they may need to conform to the larger
economies' goals or risk economic ruin due to an imbalance in trade. Trade wars are often dependent on such tariffs and restrictions hurting an opposing economy.
Scholars debate why mercantilism dominated economic ideology for 250 years. One group, represented by Jacob Viner, sees mercantilism as simply a straightforward, common-sense system whose logical fallacies remained opaque to people at the time. This, he argues, was because people lacked the necessary analytical tools.
The second school, supported by scholars such as Robert B. Ekelund,
portrays mercantilism not as a mistake, but rather as the best possible
system for those who developed it. This school argues that rent-seeking
merchants and governments developed and enforced mercantilist policies.
Merchants benefited greatly from the enforced monopolies, bans on
foreign competition, and poverty of the workers. Governments benefited
from the high tariffs and payments from the merchants. Whereas later
economic ideas were often developed by academics and philosophers,
almost all mercantilist writers were merchants or government officials.
Monetarism
offers a third explanation for mercantilism. European trade exported
bullion to pay for goods from Asia, thus reducing the money supply and
putting downward pressure on prices and economic activity. The evidence
for this hypothesis is the lack of inflation in the British economy
until the Revolutionary and Napoleonic Wars, when paper money came into vogue.
A fourth explanation lies in the increasing professionalisation
and technification of the wars of the era, which turned the maintenance
of adequate reserve funds (in the prospect of war) into a more and more
expensive and eventually competitive business.
Mercantilism developed at a time of transition for the European economy. Isolated feudal estates were being replaced by centralized nation-states
as the focus of power. Technological changes in shipping and the growth
of urban centers led to a rapid increase in international trade. Mercantilism focused on how this trade could best aid the states. Another important change was the introduction of double-entry bookkeeping
and modern accounting. This accounting made extremely clear the inflow
and outflow of trade, contributing to the close scrutiny given to the
balance of trade. New markets and new mines propelled foreign trade to previously
inconceivable volumes, resulting in "the great upward movement in
prices" and an increase in "the volume of merchant activity itself".
Before mercantilism, the most important work in economics in Europe was that of the medieval scholastic
theorists. The goal of these thinkers was to find an economic system
compatible with Christian doctrines of piety and justice. They focused
mainly on microeconomics
and on local exchanges between individuals. Mercantilism was closely
aligned with the other theories and ideas that began to replace the
medieval worldview. This period saw the adoption of Machiavellianrealpolitik and the primacy of the raison d'état in international relations.
The mercantilist idea of all trade as a zero-sum game, in which each
side was trying to best the other in a ruthless competition, was
integral to the works of Thomas Hobbes. This dark view of human nature also fit well with the Puritan view of the world, and some of the most stridently mercantilist legislation, such as the Navigation Ordinance of 1651, was enacted by the government of Oliver Cromwell.
Jean-Baptiste Colbert's
work in 17th-century France came to exemplify classical mercantilism.
In the English-speaking world, its ideas were criticized by Adam Smith with the publication of The Wealth of Nations in 1776 and later by David Ricardo with his explanation of comparative advantage. Mercantilism was rejected by Britain and France by the mid-19th century. The British Empire embraced free trade and used its power as the financial center of the world to promote the same. The Guyanese historian Walter Rodney
describes mercantilism as the period of the worldwide development of
European commerce which began in the 15th century with the voyages of
Portuguese and Spanish explorers to Africa, Asia, and the New World.
End of mercantilism
Adam Smith, David Hume, Edward Gibbon, Voltaire and Jean-Jacques Rousseau
were the founding fathers of anti-mercantilist thought. A number of
scholars found important flaws in mercantilism long before Smith
developed an ideology that could fully replace it. Critics such as Hume,
Dudley North and John Locke undermined much of mercantilism and it steadily lost favor during the 18th century.
In 1690, Locke argued that prices vary in proportion to the quantity of money. Locke's Second Treatise
also points towards the heart of the anti-mercantilist critique: that
the wealth of the world is not fixed, but is created by human labor
(represented embryonically by Locke's labor theory of value). Mercantilists failed to understand the notions of absolute advantage and comparative advantage (this idea was only fully fleshed out in 1817 by David Ricardo) and the benefits of trade.
Hume famously noted the impossibility of the mercantilists' goal of a constant positive balance of trade. As bullion flowed into one country, the supply would increase, and the
value of bullion in that state would steadily decline relative to other
goods. Conversely, in the state exporting bullion, its value would
slowly rise. Eventually, it would no longer be cost-effective to export
goods from the high-price country to the low-price country, and the
balance of trade would reverse. Mercantilists fundamentally
misunderstood this, long arguing that an increase in the money supply
simply meant that everyone gets richer.
The importance placed on bullion was also a central target, even
if many mercantilists had themselves begun to de-emphasize the
importance of gold and silver. Adam Smith noted that at the core of the
mercantile system was the "popular folly of confusing wealth with
money", that bullion was just the same as any other commodity, and that
there was no reason to give it special treatment. More recently, scholars have discounted the accuracy of this critique.
They believe Mun and Misselden were not making this mistake in the
1620s, and point to their followers Josiah Child and Charles Davenant,
who in 1699 wrote, "Gold and Silver are indeed the Measures of Trade,
but that the Spring and Original of it, in all nations is the Natural or
Artificial Product of the Country; that is to say, what this Land or
what this Labour and Industry Produces." The critique that mercantilism was a form of rent seeking has also seen criticism, as scholars such as Jacob Viner
in the 1930s pointed out that merchant mercantilists such as Mun
understood that they would not gain by higher prices for English wares
abroad.
The first school to completely reject mercantilism was the
physiocrats, who developed their theories in France. Their theories also
had several important problems, and the replacement of mercantilism did
not come until Adam Smith published The Wealth of Nations in 1776. This book outlines the basics of what is today known as classical economics.
Smith spent a considerable portion of the book rebutting the arguments
of the mercantilists, though often these are simplified or exaggerated
versions of mercantilist thought.
Scholars are also divided over the cause of mercantilism's end.
Those who believe the theory was simply an error hold that its
replacement was inevitable as soon as Smith's more accurate ideas were
unveiled. Those who feel that mercantilism amounted to rent-seeking hold
that it ended only when major power shifts occurred. In Britain,
mercantilism faded as the Parliament gained the monarch's power to grant
monopolies. While the wealthy capitalists who controlled the House of
Commons benefited from these monopolies, Parliament found it difficult
to implement them because of the high cost of group decision making.
Mercantilist regulations were steadily removed over the course of
the 18th century in Britain, and during the 19th century, the British
government fully embraced free trade and Smith's laissez-faire
economics. On the continent, the process was somewhat different. In
France, economic control remained in the hands of the royal family, and
mercantilism continued until the French Revolution. In Germany, mercantilism remained an important ideology in the 19th and early 20th centuries, when the historical school of economics was paramount.
Legacy
Adam Smith criticized the mercantile doctrine that prioritized
production in the economy; he maintained that consumption was of prime
significance. Additionally, the mercantile system was well-liked by the
traders as it involved what is now referred to as rent seeking.
In specific instances, protectionist mercantilist policies also
had an important and positive impact on the state that enacted them.
Adam Smith, for instance, praised England's Navigation Acts
of 1660 to 1760, as they greatly fostered the expansion of the British
merchant fleet and played a central role in turning Britain into the
world's naval and economic superpower from the 18th century onward. Some economists thus feel that protecting infant industries, while causing short-term harm, can be beneficial to a specific economy in the long term.
In the 20th century, John Maynard Keynes
(1883-1946) affirmed that motivating the production process was as
significant as encouraging consumption, which benefited the new
mercantilism. Keynes also affirmed that in the post-classical period the
primary focus on gold- and silver-supplies (bullion) was rational.
During the era before paper money, an increase in gold and silver was one of the ways of mercantilism increasing an economy's reserve or the supply of money.
Keynes reiterated that the doctrines advocated by mercantilism aided
the improvement of both the domestic and foreign outlay — domestic
because the policies lowered the domestic rate of interest, and
investment by foreigners by tending to create a favorable balance of
trade. Keynes and other economists of the 20th century also realized that the balance of payments is an important concern. Keynes also supported government intervention in the economy as necessary, as did mercantilism.
As of 2010, the word "mercantilism" remained a pejorative term, often used to attack various forms of protectionism.
Paul Samuelson,
writing within a Keynesian framework, wrote of mercantilism: "With
employment less than full and Net National Product suboptimal, all the
debunked mercantilist arguments turn out to be valid."
Mercantilism, which reached its height in the Europe of the seventeenth and eighteenth centuries, was a system of statism
which employed economic fallacy to build up a structure of imperial
state power, as well as special subsidy and monopolistic privilege to
individuals or groups favored by the state. Thus, mercantilism held
exports should be encouraged by the government and imports discouraged.
Rothbard viewed mercantilism not as a coherent economic theory but
rather as a series of post-hoc rationalizations for various economic
policies by interested parties.
After the re-election of Donald Trump as president of the United States in 2024, Serbian-American economist Branko Milanović
described Trump's policies of implementing tariffs on imports, trade
blocs, and other barriers against China as "neo-mercantilism", stating
that it "marks a symbolic end to global neoliberalism".
Michael Strain of the conservative think-tank the American Enterprise Institute
also described Trump's policy as a return to mercantilism: "We are
seeing a combination of true-believing mercantilism, shocking ignorance
about how the global economy works, and shocking incompetence in the
planning and execution of economic policy."
Crony capitalism, sometimes also called simply cronyism, is a pejorative term used in political discourse to describe a situation in which businesses profit from a close relationship with state power, either through an anti-competitive regulatory environment, direct government largesse, or corruption. Examples given for crony capitalism include the obtainment of permits, government grants, tax breaks, or other undue influence from businesses over the state's deployment of
public goods, for example, mining concessions for primary commodities
or contracts for public works. In other words, it is used to describe a situation where businesses thrive not as a result of free enterprise, but rather collusion between the business class and the political class
Wealth is then accumulated not merely by making a profit in the market, but through profiteering by rent seeking using this monopoly or oligopoly. Entrepreneurship and innovative practices that seek to reward risk are stifled since the value-added is little by crony businesses, as hardly anything of significant value is created by them, with transactions taking the form of trading. Crony capitalism spills over into the government, the politics, and the media, when this nexus distorts the economy and affects society to an extent it corrupts public-serving economic, political, and social ideals.
Historical usage
The first extensive use of the term "crony capitalism" came about in the 1980s to characterize the Philippine economy under the dictatorship of Ferdinand Marcos. Early uses of this term to describe the economic practices of the Marcos regime included that of Ricardo Manapat, who introduced it in his 1979 pamphlet "Some are Smarter than Others", which was later published in 1991; former Time magazine business editor George M. Taber, who used the term in a Time magazine article in 1980, and activist (and later Finance Minister) Jaime Ongpin, who used the term extensively in his writing and is sometimes credited for having coined it.
The term crony capitalism made a significant impact on the public as an explanation of the Asian financial crisis.
It is also used to describe governmental decisions favoring cronies of governmental officials.
The term is used largely interchangeably with the related term corporate welfare, although the latter is by definition specific to corporations.
In practice
South Korean President Park Geun-hye at a breakfast meeting with business magnates Lee Kun-hee and Chung Mong-koo. A group of massive, mostly family-run business conglomerates, called chaebol, dominates South Korea's economy.
Crony capitalism exists along a continuum. In its lightest form,
crony capitalism consists of collusion among market players, which is
officially tolerated or encouraged by the government. While perhaps
lightly competing against each other, they will present a unified front
(sometimes called a trade association or industry trade group) to the government in requesting subsidies, aid or regulation. For instance, newcomers to a market then need to surmount significant
barriers to entry in seeking loans, acquiring shelf space, or receiving
official sanction. Some such systems are very formalized, such as sports
leagues and the Medallion System of the taxicabs of New York City,
but often the process is more subtle, such as expanding training and
certification exams to make it more expensive for new entrants to enter a
market and thereby limiting potential competition. In technological
fields, there a system may evolve whereby new entrants may be accused of
infringing on patents that the established competitors never assert
against each other. In spite of this, some competitors may succeed when
the legal barriers are light. The term crony capitalism is generally used when these practices either
come to dominate the economy as a whole or come to dominate the most
valuable industries in an economy. Intentionally ambiguous laws and regulations are common in such
systems. Taken strictly, such laws would greatly impede practically all
business activity, but in practice, they are only erratically enforced.
The specter of having such laws suddenly brought down upon a business
provides an incentive to stay in the good graces of political officials.
Troublesome rivals who have overstepped their bounds can have these
laws suddenly enforced against them, leading to fines or even jail time.
Even in high-income democracies with well-established legal systems and
freedom of the press in place, a larger state is generally associated
with increased political corruption.
The term crony capitalism was initially applied to states involved in the 1997 Asian financial crisis,
such as Indonesia, South Korea and Thailand. In these cases, the term
was used to point out how family members of the ruling leaders became
extremely wealthy with no non-political justification. Southeast Asian nations, such as Hong Kong and Malaysia, still score very poorly in rankings measuring this. It was also used in this context as part of a broader liberal critique of economic dirigisme. The term has also been applied to the system of oligarchs in Russia. Other states to which the term has been applied include India, in particular the system after the 1990s liberalization, whereby land and other resources were given at throwaway prices in the name of public-private partnerships, the more recent coal-gate scam and cheap allocation of land and resources to Adani SEZ under the Congress and BJP governments. Similar references to crony capitalism have been made to other countries, such as Argentina and Greece. Wu Jinglian, one of China's leading economists and a longtime advocate of its transition to free markets, says that it faces two starkly contrasting futures, namely a market economy under the rule of law or crony capitalism. A dozen years later, prominent political scientist Pei Minxin concluded that the latter course had become deeply embedded in China. The anti-corruption campaign under Xi Jinping (2012–) has seen more than 100,000 high- and low-ranking Chinese officials indicted and jailed.
Many prosperous nations have also had varying amounts of cronyism throughout their history, including the United Kingdom, especially in the 1600s and 1700s, the United States and Japan.
Crony capitalism index
The Economist benchmarks countries based on a crony-capitalism index
calculated via how much economic activity occurs in industries prone to
cronyism. Its 2014 Crony Capitalism Index ranking listed Hong Kong,
Russia and Malaysia in the top three spots.
In finance
Crony capitalism in finance was found in the Second Bank of the United States.
It was a private company, but its largest stockholder was the federal
government, which owned 20%. It was an early bank regulator and grew to
be one of the most powerful organizations in the country due largely to
being the depository of the government's revenue.
More direct government involvement in a specific sector can also lead
to specific areas of crony capitalism, even if the economy as a whole
may be competitive. This is most common in natural resource sectors
through the granting of mining or drilling concessions, but it is also
possible through a process known as regulatory capture,
where the government agencies in charge of regulating an industry come
to be controlled by that industry. Governments will often establish, in
good faith, government agencies to regulate an industry.
However, the members of an industry have a very strong interest in the
actions of that regulatory body, while the rest of the citizenry are
only lightly affected. As a result, it is not uncommon for current
industry players to gain control of the watchdog and use it against
competitors. This typically takes the form of making it very expensive
for a new entrant to enter the market. An 1824 landmark United States Supreme Court ruling overturned a New York State-granted monopoly ("a veritable model of state munificence" facilitated by Robert R. Livingston, one of the Founding Fathers) for the then-revolutionary technology of steamboats. Leveraging the Supreme Court's establishment of Congressional supremacy over commerce, the Interstate Commerce Commission was established in 1887 with the intent of regulating railroad robber barons. President Grover Cleveland appointed Thomas M. Cooley, a railroad ally, as its first chairman and a permit system was used to deny access to new entrants and legalize price fixing.
The defense industry in the United States is often described as an example of crony capitalism. Connections with the Pentagon
and lobbyists in Washington are described by critics as more important
than actual competition due to the political and secretive nature of
defense contracts. In the Airbus-Boeing WTO dispute, Airbus (which receives subsidies
from European governments) has stated Boeing receives similar
subsidies, which are hidden as inefficient defense contracts and in the
form of federal and tax tax breaks. Other American defense companies were put under scrutiny for no-bid contracts for the Iraq War and Hurricane Katrina-related contracts, purportedly due to having cronies in the Bush administration.
Gerald P. O'Driscoll, former vice president at the Federal Reserve Bank of Dallas, stated that Fannie Mae and Freddie Mac became examples of crony capitalism as government backing let Fannie and Freddie dominate mortgage underwriting,
saying: "The politicians created the mortgage giants, which then
returned some of the profits to the pols—sometimes directly, as campaign
funds; sometimes as "contributions" to favored constituents".
In developing economies
In its worst form, crony capitalism can devolve into simple
corruption where any pretense of a free market is dispensed with, bribes
to government officials are considered de rigueur and tax evasion is common. This is seen in many parts of Africa and is sometimes called plutocracy (rule by wealth) or kleptocracy
(rule by theft). Kenyan economist David Ndii has repeatedly brought to
light how this system has manifested over time, occasioned by the reign
of Uhuru Kenyatta as president.
Corrupt governments may favor one set of business owners who have
close ties to the government over others. This may also be done with
religious or ethnic favoritism. For instance, Alawites in Syria have a disproportionate share of power in the government and business there (then-President Assad himself is an Alawite). This can be explained by considering personal relationships as a social network.
As government and business leaders try to accomplish various things,
they naturally turn to other powerful people for support in their
endeavors. These people form hubs in the network. In a developing
country, those hubs may be very few, thus concentrating economic and
political power in a small interlocking group.
Normally, this will be untenable to maintain in business as new
entrants will affect the market. However, if business and government are
entwined, then the government can maintain the small-hub network.
Raymond Vernon, a specialist in economics and international affairs, wrote that the Industrial Revolution
began in Great Britain because they were the first to successfully
limit the power of veto groups (typically cronies of those with power in
government) to block innovations, writing: "Unlike most other national environments, the British
environment of the early 19th century contained relatively few threats
to those who improved and applied existing inventions, whether from
business competitors, labor, or the government itself. In other
European countries, by contrast, the merchant guilds ... were a
pervasive source of veto for many centuries. This power was typically
bestowed upon them by the government." Vernon further stated that "a
steam-powered horseless carriage produced in France in 1769 was
officially suppressed." James Watt began experimenting with steam in 1763, got a patent in 1769 and began commercial production in 1775.
Raghuram Rajan, former governor of the Reserve Bank of India, has said: "One of the greatest dangers to the growth of developing countries is the middle income trap,
where crony capitalism creates oligarchies that slow down growth. If
the debate during the elections is any pointer, this is a very real
concern of the public in India today". Tavleen Singh, columnist for The Indian Express,
has disagreed. According to Singh, India's corporate success is not a
product of crony capitalism, but rather because India is no longer under
the influence of crony socialism.
Political viewpoints
While the problem is generally accepted across the political
spectrum, ideology shades the view of the problem's causes and therefore
its solutions. Political views mostly fall into two camps, which might
be called the socialist and capitalist critique. The socialist position
is that crony capitalism is the inevitable result of any strictly
capitalist system and thus, broadly democratic government must regulate
economic or wealthy interests to restrict monopoly. The capitalist
position is that natural monopolies are rare; therefore, governmental regulations generally abet established wealthy interests by restricting competition.
Socialist critique
Critics of crony capitalism, including socialists and anti-capitalists, often assert that so-called crony capitalism is simply the inevitable result of any strictly capitalist system. Jane Jacobs described it as a natural consequence of collusion between those managing power and trade, while Noam Chomsky has argued that the word crony is superfluous when describing capitalism. Since businesses make money and money leads to political power,
business will inevitably use their power to influence governments. Much
of the impetus behind campaign finance reform in the United States and in other countries is an attempt to prevent economic power from being used to take political power.
Ravi Batra argues that "all official economic measures adopted since 1981 ... have devastated the middle class" and that the Occupy Wall Street
movement should push for their repeal and thus end the influence of the
super wealthy in the political process, which he considers a
manifestation of crony capitalism.
Socialist economists, such as Robin Hahnel,
have criticized the term as an ideologically motivated attempt to cast
what is in their view the fundamental problems of capitalism as
avoidable irregularities. Socialist economists dismiss the term as an apologetic for failures of neoliberal policy and, more fundamentally, their perception of the weaknesses of market allocation.
Capitalist critique
Supporters of capitalism also generally oppose crony capitalism. Further, supporters such as classical liberals, neoliberals and right-libertarians consider it an aberration brought on by governmental favors incompatible with the free market.In the capitalist view, cronyism is the result of an excess of
interference in the market, which inevitably will result in a toxic
combination of corporations and government officials running sectors of
the economy. For instance, the Financial Times observed that, in
Vietnam during the 2010s, the primary beneficiaries of cronyism were
Communist party officials, noting also the "common practice of employing
only party members and their family members and associates to
government jobs or to jobs in state-owned enterprises."
Conservative commentator Ben Shapiro prefers to equate this problem with terms such as corporatocracy or corporatism, considered "a modern form of mercantilism", to emphasize that the only way to run a profitable business in such a
system is to have help from corrupt government officials. Likewise, Hernando de Soto said that mercantilism "is also known as 'crony' or 'noninclusive' capitalism".
Even if the initial regulation was well-intentioned (to curb
actual abuses) and even if the initial lobbying by corporations was
well-intentioned (to reduce illogical regulations), the mixture of
business and government stifles competition, a collusive result called regulatory capture. Burton W. Folsom Jr.
distinguishes those who engage in crony capitalism—designated by him as
political entrepreneurs—from those who compete in the marketplace
without special aid from the government, whom he calls market
entrepreneurs. While market entrepreneurs such as James J. Hill, Cornelius Vanderbilt and John D. Rockefeller succeeded by producing a quality product at a competitive price, political entrepreneurs such as Edward Collins in steamships and the leaders of the Union Pacific Railroad
in railroads were men who used the power of government to succeed. They
tried to gain subsidies or, in some way, use the government to stop
competitors.
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