Prominent finance economist Luigi Zingales has an excellent essay outlining some of the dangers facing us as a result of the political response to the current economic crisis [HT: my colleague Josh Wright]:
While everyone benefits from a free and competitive market, no one in particular makes huge profits from keeping the system competitive and the playing field level. True capitalism lacks a strong lobby.
That assertion might appear strange in light of the billions of dollars firms spend lobbying Congress in America, but that is exactly the point. Most lobbying seeks to tilt the playing field in one direction or another, not to level it. Most lobbying is pro-business, in the sense that it promotes the interests of existing businesses, not pro-market in the sense of fostering truly free and open competition. Open competition forces established firms to prove their competence again and again; strong successful market players therefore often use their muscle to restrict such competition, and to strengthen their positions. As a result, serious tensions emerge between a pro-market agenda and a pro-business one, though American capitalism has always managed this tension far better than most....
We thus stand at a crossroads for American capitalism. One path would channel popular rage into political support for some genuinely pro-market reforms, even if they do not serve the interests of large financial firms. By appealing to the best of the populist tradition, we can introduce limits to the power of the financial industry — or any business, for that matter — and restore those fundamental principles that give an ethical dimension to capitalism: freedom, meritocracy, a direct link between reward and effort, and a sense of responsibility that ensures that those who reap the gains also bear the losses. This would mean abandoning the notion that any firm is too big to fail, and putting rules in place that keep large financial firms from manipulating government connections to the detriment of markets. It would mean adopting a pro-market, rather than pro-business, approach to the economy.
The alternative path is to soothe the popular rage with measures like limits on executive bonuses while shoring up the position of the largest financial players, making them dependent on government and making the larger economy dependent on them. Such measures play to the crowd in the moment, but threaten the financial system and the public standing of American capitalism in the long run. They also reinforce the very practices that caused the crisis. This is the path to big-business capitalism: a path that blurs the distinction between pro-market and pro-business policies, and so imperils the unique faith the American people have long displayed in the legitimacy of democratic capitalism.
Unfortunately, it looks for now like the Obama administration has chosen this latter path. It is a choice that threatens to launch us on that vicious spiral of more public resentment and more corporatist crony capitalism so common abroad — trampling in the process the economic exceptionalism that has been so crucial for American prosperity. When the dust has cleared and the panic has abated, this may well turn out to be the most serious and damaging consequence of the financial crisis for American capitalism.
The distinction between a "pro-business" agenda and a pro-market one is a crucial point that I have often emphasized myself (see here and here). Unfortunately, it is routinely ignored or misunderstood. For the reasons Zingales points out, business interests regularly lobby in favor of government intervention whenever they think it might protect them from competition or secure government-provided privileges.
Such lobbying is of course routine. But it is particularly dangerous in the midst of a crisis atmosphere, when the combination of fear, voter ignorance, and government officials seeking to expand their power creates unusually attractive opportunities for interest groups to lobby for special privileges for themselves under the guise of emergency measures. I discussed these issues in greater depth in a series of posts last fall (see here, here, and here). So far, little has happened to alleviate my concern that the combination of economic crisis, voter ignorance, interest group lobbying, and united Democratic control of the federal government is likely to lead to a dangerous expansion of government power over the economy. In many cases, that expansion is taking the form of measures that benefit big business and other powerful interest groups at the expense of the general public.