Monday, May 31, 2010

High Powered Government Connections Don't Help, Long Term

I have long suspected that being connected to the power elite makes a firm/industry sluggish and non-competitive. Instead of looking for ways to compete on the market such firms/industries tend to look for a government solution to a problem. They eventually get so caught up in the bureaucratic red tape that they spawned that those firms/industries slip into a slow decline.

For example, pre 9-11, if you had an airline ticket in any name, you could board a plane. The idea of checking names against tickets was the idea of the airline industry under the cover of the 9-11 emergency. They didn't want to institute this program on their own, on an airline by airline basis, because some airlines wouldn't play along and those airlines would have a competitive advantage. Pre 9-11, by allowing any one to board, who had a ticket, airlines were losing money from those who bought a secondary ticket from a ticket holder who couldn't fly but had a ticket. The classifieds in major cities used to have many, many ads of people selling their tickets. The airlines wanted to stop that secondary market and make those tickets worthless and force all those who flew to buy new tickets directly from the airlines.

Under the guise of the 9-11 emergency, ID checks became mandatory. This became an instant windfall for the airlines, but overtime the charade that goes on to now board a plane expands and expands. This makes many forego flying for short trips, which, of course, is a negative for the airline industry. Further, the ID checking requirements have become more onerous as airlines are now required to check passenger lists against the most up to date no fly lists, which by the way, did not prevent the shoe bomber, the underwear bomber or the Times Square bomber from getting on planes. All this increases costs for the airlines.

Bottom line: The airline industry instigated the ID check program and they are now caught up in the multi-faceted bureaucratic expansion around the initial program that is forcing down revenues and increasing costs. This shouldn't be viewed as an isolated incident. It is an object lesson in how firms/industries who seek out government coerced regulation eventually see the coercion turned on them.

Recent empirical studies at Harvard Business School began with the premise that as a state's congressional delegation grew in stature and power in Washington, D.C., local businesses would benefit from the increased federal spending sure to come their way.

It turned out quite the opposite. I'm not surprised.

However the researchers, professors Lauren Cohen, Joshua Coval, and Christopher Malloy were surprised. They discovered, as I would expect, that companies experienced lower sales and retrenched;by cutting payroll, and other expenses. Indeed, in the years that followed a congressman's ascendancy to the chairmanship of a powerful committee, the average firm in his state cut back capital expenditures by roughly 15 percent, according to their working paper, "Do Powerful Politicians Cause Corporate Downsizing?"

Cohen, Coval and Malloy attribute the problem to the financial crowding out effect. I'm not sure that's the case because there is no evidence that money going into one state has the direct same amount drained out from that state. On the overall national economy this is the case, but not necessarily at the state level. I think what they have measured is a result of regulation suffocation that was initially introduced by a firm/industry that had access to a powerful legislator but where the regulations, a la the airline industry, turned on those who originally sought the government intervention.

See a Harvard interview with Coval, here.


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