So, why does cronyism occur? In my paper, entitled The Economics and History of Cronyism,released today by the Mercatus Center, I cite two factors: government power over the economy and the discretionary power available to particular government officials. If there was ever a doubt that this connection existed, consider this study from MIT, which shows that in the days following the leak of Tim Geithner’s appointment to Treasury Secretary, stocks of firms having any pre-existing connection to him jumped by about 15 percent. Clearly, the market expected firms that were connected to Geithner to do better, all other things equal.Henderson continues:
So what’s wrong with this cozy relationship between business and government? It’s not just that cronyism takes wealth from the less politically organized to give to the more politically organized, but also that this taking and giving destroys wealth. For example, when the government bails out its cronies (think former Treasury Secretary Paulson and AIG), it destroys wealth in several ways.
Finally, when politicians dispense special privileges to certain businesses, a vicious cycle ensues: Businesses put their financial resources towards currying favor with politicians rather than investing those resources in their product and their customers.