Train passing by Surabaya

The Plague of Crony Capitalism

Growth Watch – Underdogs Uninterrupted.

Bio: Part-time Potterhead and a full-time finance student, Prachi will cover emerging markets for Woroni this semester. She’s always up for discussions on politics and economics and loves to binge watch Oprah interviews. Join her as she chronicles the growth stories of emerging economies all the way from Mexico through to Indonesia.

‘A full man can’t understand a hungry man,’ says Yuri Bykov, a 36-year-old Russian filmmaker who is due to start work on his upcoming project, The Factory. It’s a story about workers, angered by the shutting of the factory they work in, owing to its lack of economic viability. Furious, they hatch a conspiracy to lure their employer, the oligarch who owns the factory, into their premises and take him hostage.

According to CNBC, Russia is the most unequal major economy in the world. The alarming disparities are traceable back to the early 1990’s. Post the fall of the Soviet Union, privatisation of public enterprises at throwaway prices helped a select few- those with access to capital. Oligarchs well connected to Yeltsin, the then President, mounted the ladders to prosperity. The rest were left to be devoured by snakes. Nearly three decades on, Russia, with 118 of its people having a net worth of over $1 billion, has the fourth highest number of billionaires in the world. Most of them holdovers from the same club that acquired companies at knockout prices in Yeltsin’s fire sale. Yet, it doesn’t even figure in the top 18 in Credit Suisse’s ranking of countries by most number of millionaires. By contrast, China finished second on the list of most billionaires and sixth on that of the millionaires.

As anti-corruption protests rocked various cities across Russia earlier this year, Bykov’s work is seen as an expression of the resentment that is slowly but surely brewing amongst the less privileged Russians.

10 per cent of Russians own over 87 per cent of the country’s wealth whereas the same figure stands at 66 per cent for China. The monopoly enjoyed by the oligarchs has resulted in a drag on innovation. Most of the 27 Russian companies that made the Forbes’ Global2000 list this year were natural oil and gas companies.

The incoming 2018 presidential elections will exacerbate these problems further. At the same time, the perceived passiveness to inequality of the hoi polloi is gradually evaporating and the opposition is capitalising on this in the lead up to the election. Given this context, the the existing regime, regardless of all tacks to consolidate power, could see the public sentiment turn the tide against it.

Indonesia is a classic example of how disillusionment of the people can bring down autocratic rulers even after a run at the top spanning decades. The Asian financial crisis of the late 1990’s brought the anger of the Indonesian people to the surface in a manner more violent than in any other country that the economic meltdown had an impact on. Indonesia saw its GDP plummet by more than 25 per cent and its currency fall by 70 per cent in value. In 1998 the then President, Suharto, in the face of massive protests, decided to step down after a reign that lasted 32 years. Up until that point, major businesses in almost every industry in the country – automobiles, cement, paper or communications, were owned by the Suharto family or those close to the President. The major benefits that these corporations enjoyed were in the form of generous tax breaks and monopoly rights granted by government. This allowed the companies to undercut the foreign competition, which drove away precious foreign investment, essential for the growth of an emerging economy. The Suharto family reportedly owned undisclosed assets that totalled $30 billion. They would have ranked amongst the world’s dozen richest families. This run of crony capitalism was brought to a screeching halt when the IMF bailout package, to rescue Indonesia from the pits of the crisis, demanded the dismantling of all business cartels and monopoly rights enjoyed by well-connected oligarchs. Most importantly, it asked the Suharto family to give up substantial parts of its family-run business empire. Indonesia has since seen business activity thrive in places other than Jakarta, where most of the former oligarchs were based. Emerging cities like Surabaya and Bandung have made for a more equitable pattern of growth.

Nearly all emerging markets see largely inequitable growth patterns for some stretch of time. The rule of thumb states that the benefits of growth usually even out eventually. However, Mexico has been an outlier on the wealth inequality front. Business owners grapple for the markets to remain closed to foreign competitors and vie for the goodwill of the politicians and not so much the consumers. Carlos Slim, the wealthiest Mexican, accounts for seven per cent of the country’s GDP. The list of billionaires has seen nearly no churn in the last few decades. The roots of Mexican oligarchy is easily traced back to government debt crisis of the 1980’s. In much the same manner as Yeltsin, the government sold off state-owned enterprises to a few cronies at dirt cheap prices. Today, the wealthiest 10 families control nearly all the major industries – chemicals, iron and steel, tourism, petroleum and consumer durables and account for a third of the value of the stock market. Since private cartels produce close to 40 per cent of consumer goods used by the Mexican people, price levels are 30 per cent higher than international averages.

The Gini coefficient measures income inequality in a country. At 0, there’s no inequality, and at 1, all the wealth is possessed by a single individual. Mexico’s Gini coefficient stands at .48.

The worth of individuals involved in crony industries around the world increased by 385 per cent from 2004 to 2014 and makes up a third of all billionaire wealth worldwide. As wealth concentration in a few hands grows, a fallout of this phenomenon is the resentment of the rich amongst the less privileged. In emerging Latin American economies, for instance, this has forced wealthy businesspeople to lie low and avoid ostentatious displays of wealth. They travel around in bullet-proof vehicles surrounded by a band of bodyguards. It comes as no surprise that Brazil is the second largest market for armoured cars in the world.

Around the world, the poor, disenchanted with corruption fuelled social inequality, are increasingly turning to populist leaders. The recent elections in Europe bear testimony to this fact. However, populist or autocratic rulers are to worsen the situation further. Crackdown on civil liberties and freedom of the press as seen in Hungary and Turkey, two countries experiencing the rise of autocratic rulers, confirms this.

Ensuring equitable growth is tightrope walking between ensuring efficient allocation of capital to the right industries and firms on the one hand and ensuring all economic agents get an equal share of the pie on the other. The ills of crony capitalism, divorced from the latter half of its namesake and what it means- a free market. For what is crony capitalism but those in power twisting the rules in favour of a few, rendering the market not free? This can be to a large extent, alleviated if instead of the sucking of economic marrow into favoured mouths, the markets are left to clear by themselves, sans any political intervention.