Socialism, Competition and Politicians

This piece is a brief response to a twitter exchange I had last month.

@atanudey @ccsindia Would you say the same for China and also why are most politicians in capitalist USA fabulously rich?

— Nikhilesh Sinha (@falleneconomist) June 24, 2015

In his tweet, Mr @falleneconomist questions my assertion that socialism impoverishes countries. He implies that my claim cannot be correct and lists two facts (no doubt limited to only two because of the 140-character twitter limit) to support his contrary position: first, that China is doing well despite it being a socialist country; and second, “most politicians in capitalist USA are fabulously rich.”

It’s true that China is a socialist country. It has been socialist/communist ever since Mao Zedong established the People’s Republic of China in Oct 1949. His Communist Party of China (CPC) undertook “The Great Leap Forward” between 1958 and 1961 to transform China’s agrarian economy into an industrialized one through collectivization. The result was the horror of mass starvation that is known as “The Great Famine.” Chinese government statistics put excess death during that period at 15 million but independent observers estimate the death toll to be between 20 and 43 million.

Communism is not kind to people. Here’s an eye-witness account by a Chinese government official.

I went to one village and saw 100 corpses, then another village and another 100 corpses. No one paid attention to them. People said that dogs were eating the bodies. Not true, I said. The dogs had long ago been eaten by the people.

The communist mismanagement of the economy kept China desperately poor — so poor that it was even slightly below impoverished India as late as 1978. Then something happened to China. Deng Xiaoping. Deng led China’s revival with market-economy reforms. To the extent that China moved away from socialism, it has prospered. China’s story underlines the importance of freeing an economy from the shackles of socialist centralized command and control. Although China is not a market economy, to the degree that it has adopted a free-market attitude, it has prospered. By 2015, China’s economy has left India’s socialist economy in the dust because India steadfastly refuses to reform.

So in short: The steps that helped China climb part way out of extreme poverty were steps away from socialism.

Mr @falleneconomist’s second point was about the fabulously rich politicians in the US. Fabulously rich politicians are not uncommon. But the norm is that fabulously rich politicians go hand in hand with extremely impoverished countries. Which makes it unlikely that the US will have fabulously rich politicians, considering that the US is not an impoverished country. Let’s examine the evidence.

For a start, let’s agree what “fabulously rich” means in the context of the US and other developed nations. Buffet, Gates, et al, with their net worth counted in the tens of billions are fabulously rich. Others with net worth in the hundreds of millions are rich but not fabulously so. No politician makes the fabulously rich club. Moreover, even for those politicians who are rich by whatever standards, we need to ask if they were rich before or after they attained political office.

Some politicians in the US are rich but not fabulously so. Rich politicians in the US have always been rich first and then become politicians. Take Michael Bloomberg, for example. By the time he became the mayor of New York City in 2002 (re-elected in 2005 and 2000), he was already a wealthy man, having been the CEO of his own company for over 20 years. It is true that by 2013, Bloomberg’s $33 billion (estimated by Forbes) made his the 13th richest man in the world. But the perks of political office had nothing to do with his wealth.

This is not to imply that political power does not confer some financial benefits; it does. There are laws against blatant misuse of political privilege and on the rare occasion when greed does overcome prudence, the punishment is almost always guaranteed. This provides sufficient barriers to considering political power as the road to fabulous riches. The plain fact in the US is that there are ample opportunities for becoming wealthy but being a politician is not one of them. Want to be wealthy in the US? Build a successful business.

So, there are no fabulously rich in the US who became so as politicians. Perhaps you mean some third-world socialist country. India, for example.

In India, in contrast to the US, being a politician is a sure-fire method of becoming wealthy. Even municipal corporators in two-bit towns rake in the moolah through public works contracts. They are the small fry. Average MLAs and MPs make hundreds of crores. Ministers and chief ministers of states take the stuff away in truckloads. One ex-chief minister of a large state is reported to be worth tens of billions of dollars. One chief of a major political party was reported to be among the top 10 wealthiest politicians in the world. One ex-prime minister from the same party had a few billion dollars in a foreign bank account. He was definitely not an exception.

We have heard stories of immense wealth being stashed in “Swiss banks.” Let’s think about who the owners of these accounts could be. Could they be people who made their money in business? Unlikely. Because if some rich businessman had a spare billion or two, he would put it in his business or in property. He would make the money work for him. Putting it in a foreign bank does him no good. Certainly, he may keep some spare change abroad. But the bulk of a businessman’s wealth is tied up in his business.

The people who keep their wealth abroad are the kind who made their money through political means, not business. In India, the way to make your billions is through “crony capitalism.” The economy is specifically designed and structured for wealth extraction using political means. Here’s the short-form narrative of how this works.

The Indian government is mandated to control the economy for “public interest” reasons. That gives those in government immense discretionary powers to hand out licences, permits, quotas, subsidies, commercial contracts, etc., to companies it favors — its cronies. Controlled markets means that competition is limited, which lead to super-normal profits (“rents” as economists call them.) Part of these profits are shared with the politicians and bureaucrats.

On a side note, I have a conjecture which I call the “conservation of competition.” In free-markets, there’s a certain amount of competition in various sectors. If free entry is allowed, the competition in the market segment leads to normal economic profits (which means zero economics profits or zero rents). But if free entry is not allowed, then it gives rise to rents. Competition then shifts up one level: competition for the market. That’s called “rent-seeking”. My conjecture is that the less competition there is in the market, the more competition there is for the market. Hence the conservation of competition.

To make the idea a little more concrete, imagine that in a free-entry regime, firms will compete for the market for cars until all rents are competed away. But if the government restricts entry into the market and gives only two firms the license to serve the auto sector, and assigns quotas on how many cars each firm can sell in the market, then these firms will make super-economic profits. Automotive firms will then compete for the license and quota to serve the market. This competition is resolved in favor of those firms that will pay for most for the privilege. This allows the licensing authority — politicians and the associated bureaucrats — to become wealthy.

The story does not end there. By shifting the competition from in the market to competition for the market, it leads to yet another higher level competition: the competition for being the licensing authority. That is, suppose being the “Minister of Industries” gives one the opportunity to make, say, billions of dollars a year. That attracts the greediest to compete in the political race. So they would be willing to spend quite a bit — hundreds of millions — to win the political race so that they can make the billions.

In functional notation:

(Competition for the market) + (Competition in the market) = Constant . . . (1)

(Competition for political office) = increasing function of (Competition for the market) . . . (2)

It follows from (1) and (2),

(Competition for political office) is a decreasing function of (Competition in the market.)

In a sense, the absence of free markets (which for brevity we will define here as markets with free entry and exit) leads to competition for the market, which leads to competition for political office, which leads to the corruption of politics. That’s the basic story of crony capitalism — a side-effect of socialism.

Here ends my brief response to Mr @falleneconomist.