It’s time to reject crony capitalism and embrace the real thing

It is a real tragedy that so many of the great and the good who are meeting in Davos this week don’t really understand the difference between genuine free-markets and crony capitalism. If they did, they wouldn’t be talking so much muddled nonsense about inequality, one of the key themes at this year’s World Economic Forum.

Real business people, who make their money in open, competitive markets, are entitled to their vast wealth but crony capitalists, who rely on state privileges, don’t deserve our support. The Left and the Right have both got it wrong here: the former wrongly attack all inequality; the latter wrongly defend all of it.

The blunt reality is that all societies are highly unequal, even supposedly communist ones. What really matters is the source of the inequality: are the wealthy rich because they looted everybody else, as was inevitably the case in feudal, pre-commercial societies, or are they prosperous because they profited from serving the needs of others in a competitive market? Is a society open to new talent and ideas, and encouraging of social mobility, or is it controlled by a small economic and political aristocracy that doesn’t let anybody else climb to the top?

Whether inequality is good or bad depends on the answer to those questions; merely bashing the top 0.1pc, as has become fashionable once more, is to substitute clear thinking for destructive, simplistic demagoguery.

There are two ways businesses and investors can make money legally.

The first is by providing goods and services that people want, by working out correctly what assets will be in most demand or by investing capital in successful projects, all activities that boost economic growth, increase employment, help develop poor economies and lift living standards.

This is what the likes of Sir Richard Branson, Facebook’s Mark Zuckerberg or the financier Warren Buffett have achieved and their vast wealth is their just reward. We need more of these kinds of people and we must incentivise them to be as successful as possible.

Most business people and entrepreneurs in the UK fit in this category and, contrary to what many believe, finance, when practised properly, honestly and prudently, is a socially useful activity like any other and should not be singled out for opprobrium.

The second way that businesses and investors can make money is by getting the government to rig markets in their favour – by erecting barriers to entry to restrict competition, by providing them with cheap credit or by allowing them to use their political connections to grab contracts and other privileges. These gains are not the fruit of value-adding economic activity. Rather than helping to grow the economy, they often merely redistribute wealth.

There have been far too many examples of this kind of behaviour in recent years in the West, in Russia, in Latin America and in most other parts of the world. Tragically, our economic systems have been moving away from commercial relationships and becoming ever more politicised.

In no developed country have the effects of this shift been as apparent as in the US. Remarkably, counties in and around Washington, DC have become among the most prosperous in the US. They are populated with lawyers, lobbyists, contractors and others who derive their income from doing deals with politicians.

Incomes in the District of Columbia itself have done better than in any other US state in recent years: between 2000 and 2012, they surged an astonishing 23.3pc, according to the US Census Bureau, compared with a national slump in median household incomes of 6.6pc. The highest earners are often ex-Congressmen or ex-political staffers who have switched into lobbying, milking their connections rather than any inherent ability to satisfy consumers in a real free-market.

This wasn’t the case in the 1980s and early 1990s, when incomes in Washington didn’t rise as much or even fell and were left behind by states powered by the private sector. The rot only really set in after the late 1990s under the Clinton, Bush and Obama administrations.

Britain made a temporary break from crony capitalism during Margaret Thatcher’s time in office, when state-owned industries were sold off, subsidies slashed and competition increased. To survive, old businesses had to reinvent themselves; their future was no longer determined by the cosiness of their relationship with politicians or by the hold of their unionised workforces on MPs in marginal seats. All of this has now gone into reverse again. Politicians and companies have jumped back into bed together and industrial policies, subsidies and corporatism have become fashionable again.

It started to go wrong during the Labour years, with the rise of badly designed private finance initiative projects and wasteful, incompetently managed procurement contracts. The biggest mistake was in banking, where implicit subsidies allowed institutions to leverage up too much, safe in the knowledge that they wouldn’t be allowed to go bust. This helped boost returns. The railways became dominated by a strange mix of profit-seeking, subsidies and state direction, where pleasing the Treasury was more important than serving the customer.

Energy companies ceased to defend their customers’ interests and chose instead to embrace the costly green energy promoted by politicians. Land prices were pushed up by stultifying planning rules, with developers reliant on politicians for their success; a system of shadow payments emerged whereby those seeking to build new homes would have to offer to build roads or other buildings for councils in return.

Some of this has been tackled by the Coalition but in many ways the situation has been getting worse rather than better. Banking is now a joint venture between state and private sectors, with subsidised credit, lending targets, pay caps and endless political grandstanding. Ministers have become salespeople abroad for favoured UK industries. Quantitative easing has helped those with homes but hurt those with savings.

Tragically, the remedies being proposed by the Left – yet more regulations and tax – will merely reinforce corporatism, entrench current power structures and make it harder for entrepreneurs to break through.

Higher minimum wages were originally welcomed by some large retailers because they knew they would hurt small rivals. Big companies find it easier to hire the compliance officers needed to deal with red tape; in finance, large banks are more easily able to afford the vast amounts of capital now required, freezing out challengers, and lawyers and accountants will have even more fun.

There is a simple answer to all of this and it doesn’t involve punitive taxation, demonising the rich or fuelling jealously. The solution is to promote competition, tear up barriers to entry, unleash consumer choice, eliminate subsidies and soft loans and make sure that the only way an entrepreneur, a CEO, a banker or an investor can make money is by serving customers, discovering new opportunities or allocating capital more efficiently.

If the denizens of Davos are serious about making the world a fairer place, they need to reject crony capitalism and embrace the real thing.

Allister Heath is editor of City AM