“The Ability of Companies to Subvert the Operating Rules for the Market is a Deep, Systematic, Durable Force”

In this installment of ProMarket’s new interview series, we ask Harvard Business School professor Herman “Dutch” Leonard about the involvement of corporations in politics and his thoughts on the Trump presidency. “Globalization, rent-seeking, and regulatory capture are not unrelated to one another.”

 

 

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On March 3-4, the Stigler Center at the University of Chicago Booth School of Business, along with Harvard Business School and Oxford University, will host a conference in Chicago to answer the following questions: Should the economic theory of the firm be modified? And if so, how?

 

The standard (economic) theory of the firm is silent on the role firms can play in shaping the rules of the game under which they operate. In reality, many firms lobby politicians and try to capture regulators in order to modify the rules of the game in their favor. Some scholars have argued that the resources devoted to these activities are relatively so small that they are likely to have insignificant effects, and/or that regardless of how much firms invest in political activities, in a well-functioning democracy there are countervailing forces that effectively level the playing field. Other scholars have noted that the resources firms devote to shaping the rules of the game to their own advantage are sufficiently large and their effects sufficiently important to warrant a rethinking of the standard economic theory of the firm. Which of these two views has more empirical support? If the latter, should the economic theory of the firm be modified? If so, how, and is the potential fix better or worse than the existing problem?

 

The following interview with Harvard Business School professor Herman “Dutch” Leonard is part of an interview series with influential scholars who are addressing these issues in their work. You can view all previous installments here 


 

Herman "Dutch" Leonard. Photo by Martha Stewart
Herman “Dutch” Leonard. Photo by Martha Stewart

Herman (“Dutch”) Leonard is the Eliot I. Snider and Family Professor of Business Administration at the Harvard Business School and the George F. Baker, Jr. Professor of Public Sector Management at Harvard University’s John F. Kennedy School of Government. He is also the co-chair of the HBS Social Enterprise Initiative. His academic work focuses on general organizational strategy, governance, performance management, crisis management and leadership, and corporate social responsibility. He has also worked on innovation, creativity, effective decision-making, and the relationship between governance, accountability, and performance.

 

In a brief interview with ProMarket, Leonard shared some thoughts on the involvement of corporations in politics and the Trump presidency.

 

Q: The neoclassical theory of the firm does not consider political engagement by corporations. How big of an omission do you think this is?

 

This is a very large omission. The specified rules of order in the market are fundamental to our understanding of why we should expect markets to provide improvements in social welfare. The rules of how markets are supposed to work are fundamental premises of the social welfare theorems of economics; when the rules become endogenous to the actions of the participants in the market, we have no basis for assurance that the results of the market are even in the direction of social welfare (let alone any basis for hope for the possibility that the market maximizes social welfare in the commonly understood meaning of that phrase).

 

Q: To what extent is political engagement by corporations responsible for the current populist discontent?

 

It is hard to answer this as a general question. The link is certainly indirect. What has generated a lot of populist discontent is that the gains from economic expansion have not been very broadly shared, and there are major categories of workers who have seen no gains or have suffered losses. That is in part a result of political interventions on behalf of concentrated economic interests, and it is one of the sources of populist unhappiness—so these phenomena are entangled. 

 

It may be easier to think about this by looking at some examples of specific phenomena—smaller in scale, and thus only explaining part of the surge in populism, but nonetheless illustrative. As an example, some forms of political engagement by corporations and other financial interests have had a significant impact on generating and sustaining rules of operation in financial markets that have resulted in a fantastic concentration of wealth among a very small number of people … to the extent that a very large fraction of the gains in the economy have been captured and thus not shared broadly by line workers.

 

Q: The World Economic Forum has called for “reimagining” and “reforming” capitalism. To what extent is this need for reform the result of disruption brought by technological change, globalization, and immigration and to what extent is it the effect of rent-seeking and regulatory capture?

 

All of those forces are probably important. And, notably, globalization, on the one hand, and rent-seeking and regulatory capture, on the other, are not unrelated to one another.

 

Q: Some people describe Donald Trump’s economic policies as “corporatism.” Are you more worried by Trump’s interference in the market economy or by companies’ ability to subvert markets’ rules?

 

I have no idea at this point what Trump’s policies are (and I don’t think anyone does—including him). His views on practically everything are subject to rapid, nonlinear, and often incomprehensible evolution … so predictions about them should be made cautiously (at best). 

 

I guess I would say I am worried about both Trump’s rather random salients into the market economy and about companies’ ability to subvert market rules … but it is a big economy and Trump can’t individually police the actions of the vast majority of corporations and other market players, so in the end I think most of his interventions will be symbolic and, while much will be made of them, they won’t actually have a very large effect (either directly on the firms he visits his attention on or through the influence of those actions being viewed by other firms as threats).

 

It is important to note that both sides—Trump supporters and Trump resisters—have every incentive to overstate the impacts he is having. He and his supporters want to claim they’ve drained the swamp and drastically reformed a broken system; resisters want to say that the sky has fallen and the republic is in peril. The truth is that there will be some impacts, but they will be less dramatic than they have been (and will be) advertised to be.

 

Meanwhile, the ability of companies to subvert the operating rules for the market is a deep, systematic, durable force pushing the economy away from the premises of the free, competitive, informed, social-welfare maximizing market. The integral of that force over time is much larger than the forays of Trump.

 

Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy. 

3 comments

  1. The only purpose of formal gatherings between agencies of the State such as the Ministry of Defence (in the UK, and Department of Defense in the US) and the Defence Industry is to facilitate clandestine political engagement between the governing elite and the business elite, with no room for the voice of the unrepresented many, like small and medium-sized enterprises to be heard. After all, SMEs are the lifeblood of any economy and should rightly be given equal access to publicly-funded contracts which have hitherto, been monopolised by the Select Few.

    Defence Contractors are accomplished practitioners in the art of clandestine political engagement, also referred to as behind-the-scenes lobbying. Instead of employing talented engineers, problem-solvers innovators and doers, they prefer to engage expensive parliamentary lobbyists so that they can deploy these people to swing the decision on down-selection, by circumventing MoD’s weak competition process – where it matters most, in the corridors of power using arguments that have nothing whatsoever to do with the qualities of the equipment being offered!

    Which would explain why the Defence Industry has failed so miserably to deliver equipment to the Armed Forces which is fit for purpose, adequately sustained in-service and constitutes value for money through-life, for as long as anyone can remember.

    It should be noted that the big players in the UK Defence Industry, the Select Few, don’t even bother to submit written evidence to parliamentary inquiries into defence procurement (an issue which has a profound impact upon their business prospects), because they consider secret, ‘back channel’ access to the Executive a much more effective way of continuing to influence policy – with the objective of keeping it skewed in their favour.

    This is, as good as any other reason, for draining the swamp!

    On the other hand, one way to skew the bias in the defence procurement process back towards MoD (or DoD) is to introduce a new Defence Industrial Strategy that puts the National Interest first, not defence equipment manufacturers’ commercial interests.

    Such a proposal is outlined in written evidence submitted to, and published by the Business, Energy and Industrial Strategy Committee of the House of Commons which is currently conducting an inquiry into Industrial Strategy.

    This submission can be downloaded as a pdf file via this link:

    http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/business-innovation-and-skills-committee/industrial-strategy/written/36606.pdf
    @JagPatel3 on twitter

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