Economy

Centre shuns crony capitalism in favour of pro-business

Vivek Ananth BL Research Bureau | Updated on February 01, 2020 Published on January 31, 2020

Accumulation of wealth in people connected to political establishment doesn’t serve the purpose of welfare of general public, says the Survey

The Economic Survey lays out the government’s vision of how to promote public welfare by shunning crony capitalism, or as the survey puts it, “pro-crony” policies. It suggests that being pro-business is a far better approach for the government as it doesn’t let companies and businesses form monopolies and survive beyond their sell-by date.

The continuation of companies in the marketplace which have accumulated power and profits because of pro-crony policies destroys value for investors in the economy and impedes the competitive market. This cycle was interrupted when there was a furore after allocations of scarce resources such as spectrum (in the 2G airwave case ) and coal (in the coal allotment case) were audited by the Comptroller and Auditor General of India in 2010.

‘Connected’ firms vs the market

The Survey makes a case for being pro-business rather than promoting crony capitalism—cornering of returns by fewer people. The use of political connections leads to pro-crony policies and rent-seeking behaviour, like manipulation of public policy to increase profits. Investors in these companies make extra return as a result of these pro-crony policies, benefiting “connected” ( i.e. politically connected) companies.

To explain this, the Survey makes use of brokerage house Ambit’s stock market index of 75 “connected” firms as a proxy for companies that benefited from pro-crony policies. It then uses the companies that form part of this index to measure the investor wealth generated by such companies.

These “connected” companies outperformed the BSE 500 index from 2007 to 2010 by at least 7 percentage points (CAGR). After the CAG’s reports on allocation of scarce resources revealed the extent to which benefits were being accumulated by these “connected” companies, the connected firms stopped outperforming the broader market.

Creative destruction and wealth creation

The rent-seeking by “connected” companies breeds inefficiency and allows companies that can’t otherwise survive in the market, the survey says. This happens when institutional checks and balances are weak.

“When opportunities for crony rent-seeking exist, firms shift their focus away from growth through competition and innovation towards building political relationships, thus undermining the economy’s capacity for wealth creation,” says the survey.

Being connected allowed “connected” companies to remain dominant in the marketplace when they should have actually not survived. This way there is no creative destruction of businesses that continue to use old methods and technologies. These companies don’t get displaced from their dominant position in the marketplace because the rules of the market are beneficial to them. This accumulation of wealth in people connected to the political establishment doesn’t serve the purpose of welfare of the general public, measured in terms of returns to investors.

Published on January 31, 2020
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