December 2011

In its first full year of business in 1998, the 99 Cents Only store in the north Los Angeles city of Lancaster did over $5 million in sales. This was welcome news to the city, given the space had been vacant ever since the new “Power Center” shopping development, where 99 Cents was located, opened ten years earlier. Almost immediately, however, 99 Cents’ next door neighbor, Costco, told the city it needed to expand. The owner of the center offered Costco optimal space behind 99 Cents, but Costco insisted that the city use its power of eminent domain to condemn 99 Cents’ business. If the city refused, Costco threatened to relocate to neighboring Palmdale, who surely would use ever tool at its disposal to attract the lucrative big box store’s business. To seal the deal, Costco issued an additional threat: not only would it relocate to Palmdale—it would leave its existing store shuttered and vacant as an economic deadweight on the city’s key commercial center. Backed against the wall, the terrified city relented. It condemned 99 Cents’ store, paid the shopping center owner $3.8 million, and give the parcel to Costco for one dollar.

This story typifies what drives all rent-seeking: Motive and opportunity. Businesses seek economic advantage wherever they can find it, and they frequently find it in the coercive power of the state. Ill-defined limits on government powers—of which eminent domain is just one example—give businesses easy access to this power. When the economy grows, the motive to capture the government intensifies. When government is centralized, the opportunities to capture it get cheaper and more convenient. When the limits on government recede, these opportunities get still cheaper and more abundant. Motive explains why rational private interests engage in rent-seeking: to gain a competitive edge. Opportunity—that is, the opportunity for access to government power through ill-defined limits on that power—explains why rational government officials yield to special interests: they face a “race to the bottom.” If the Lancasters of the world refuse to use their coercive government power for the benefit of special interests, some other government official or agency will. Denying access to special interests just means they will look elsewhere. And they will surely find it, so long as giving in to special interests is a matter of legislative “discretion.”

Motive and opportunity answers the problem of political corruption at the heart of Lawrence Lessig’s new book, Republic, Lost: How Money Corrupts Congress—and a Plan to Stop It. Corruption, for Lessig, is not limited to vile, money-in-the-briefcase, quid pro quo corruption. The kind of corruption destroying American politics is systemic, in which ordinary people—both those in power and those seeking access to it—respond logically to powerful incentives. The opportunity for access to influence in the increasingly centralized federal government is overwhelming. This access has caused trust in government to reach an all-time low. Just 12% of Americans in 2008 had confidence in Congress, falling to 11% midway through Obama’s presidency. According to Lessig’s own poll, a staggering 75% believe “campaign contributions buy results in Congress.”

The distrust is justified according to Lessig by looking at the dramatic recent increase in campaign contributions. From 1974 to 2008, the average Congressional reelection campaign surged from $56,000 to over $1.3 million. The total spent by all candidates in the eight years prior to 1982 increased 450%. By 2010, it spiked another 525% to $1.8 billion. The financial sector alone spent $1.7 billion in campaign contributions and $3.4 billion in lobbying expenses between 1998 and 2008. The contributions of just 100 financial firms since 1989 total more than those of the entire energy, health care, defense, and telecom industries combined.

The motive for all this lobbying? Access to power over a national economy that, over the past 70 years, has been increasingly centralized in a single legislature—i.e., Congress. Henry Manne recognized in 1966 that “the federal government is the largest producer of information capable of having a substantial effect on stock-market prices.” According to University of Kansas researchers, every dollar spent on lobbying in D.C. returns between $6 and $20. The effectiveness of these dollars increases exponentially for major firms. After about $800,000, an additional 1% in lobbying produces tax benefits between $4.8 and $16 million—a 600% to 2,000% return. Rational economic actors are hard pressed to find better opportunity to advance their motive. This explains why, from 1971 to 1981, the number of registered lobbying firms in D.C. jumped from 175 to almost 2,500, and to 13,700 by 2009. These firms spend about $6.5 million per federal legislator per year. These lobbyists and the special interests they represent follow the model of Tammany Hall boss George Washington Plunkitt who, in explaining his self-styled “honest graft,” said “I might sum up the whole thing by saying: ‘I seen opportunities and I took ‘em.’”

A national economy governed by a single, centralized government, offers a rich variety of opportunities to access the levers of power. Lessig offers corn subsidies as an example. High-fructose corn syrup, a new invention in 1980, enjoyed a 35% share of sugar consumption in the U.S. just five years later, and a 41% share by 2006. Not that the stuff is actually profitable. Lessig notes that “every $1 of profits earned by ADM’s corn sweetener operation costs consumers $10, and every $1 of profits earned by its ethanol operation costs taxpayers $30.” This is due to high tariffs that keep competition largely limited to eight manufacturers who receive $1 billion in extra profits from the tariffs at a cost of about $3 billion to consumers.

These policies lead to freakonomics-style unintended consequences: In addition to hurting legitimate American businesses, consumers, and developing nations, federal corn subsidies and cane tariffs contribute to the proliferation of drug-resistant suberbugs like E. coli and salmonella. Cows and their seven stomachs are evolved to digest grass. By contrast, corn digests poorly, giving bugs time to brew, making the cows sick. In response, farmers supplement the cows’ corn diet with tons of antibiotics—25 million pounds every year, eight times the amount consumed by humans. Because corn is so heavily subsidized by the federal government, however, corn feed plus 25 million pounds of drugs still costs less than grass. This proliferation of antibiotics among cows, and passed up the food chain to us, fosters stronger, antibiotic-resistant bacteria.

The federal government extends similar subsidies and protections to the dairy industry. Price setting and other regulations increase the price consumers pay for milk by 26%, cheese by 37%, and butter by 100%. Again, the principal recipients of these subsidies are those farms with the greatest access to influence: 10% of the recipients of farm subsidies collect 73% of the subsidies, while the bottom 80% take just $3,000 each on average.

At one level, none of this ought to be surprising. Special interests are nothing new, and Lessig acknowledges that the warped influence of special interests on government was “the single most important corruption that the Framers were working to cure.” Nor can we reasonably claim surprise at the effects of wealth on politics. A hundred years ago, prominent statesman Elihu Root observed that as population and wealth increased, so would rent-seeking: “[P]olitical organizations controlled the operations of government, in accordance with the wishes of the managers of the great corporations. Under these circumstances our governmental institutions were not working as they were intended to work, and a desire to break up and get away from this extra constitutional method of controlling our constitutional government has caused a great part of the new political methods of the last few years.” Teddy Roosevelt concurred: “Corporate expenditures for political purposes… have supplied one of the principal sources of corruption in our political affairs.”

At another level, however, we have reason to suspect we are suffering more injury from special interests and crony capitalism than we have a right to. Had the Constitution’s limits on federal and state government power survived the 20th century, special interests simply would not have the opportunities they have today to capture government influence. Consider the nature of the opportunity that gave Costco access to Lancaster’s eminent domain power. It wasn’t money: the Constitution did not subject protection of private property to a highest-bidder qualification. It wasn’t cronyism: Lancaster officials, caught in the crossfire between rent-seeker and the awesome authority to decide the fate of private property, did everything it could to dissuade Costco and keep both stores. Instead, the cause was ill-defined limits on the government power. As a result of a series of U.S. Supreme Court decisions (culminating in Kelo v. City of New London a few years later in 2005), Lancaster was empowered—ironically, to its own detriment—to wield the eminent domain power subject to its own discretion and effectively without judicial oversight. This created opportunity for Costco to pit one city against another to demolish its competition, all removed from the actual marketplace. Though a federal district court in 2001 invalidated Lancaster’s transfer, Kelo upheld a similar transfer four years later.

The supply of influence is increased when limits on government authority are eroded or ill-defined. This opens the floodgates of money into politics, largely in the form of independent expenditures from rational rent-seekers. Regardless of whether this results in actual buying-and-selling of votes, the more certain and more disastrous result is the erosion of legitimacy in our democratic institutions: the individual sees his voice and political contributions drowned out by special interests with motive and opportunity to conscript lawmakers into their service.

Murray Kane, a Los Angeles redevelopment lawyer who helps cities take property for government projects, is perhaps an unlikely critic of ill-defined government power, at least when it comes to eminent domain. Yet, in 1995 Mr. Kane challenged the city of Diamond Bar when it similarly extended that power as an opportunity to serve private motives. Even though his clients benefit from eminent domain, Mr. Kane warned that eroding its limits would result in “a legislative backlash.” That backlash “could go beyond stopping redevelopment abuse, and will also hurt redevelopment in truly blighted areas where redevelopment is really needed.” Power exercised never fails to instill fear. It engenders trust only when its exercise is limited, and only so long as those limits are honored.

Members of Congress have not gleaned this lesson. Lessig explains how federal legislators increase the opportunity for special interests to extort rents from government—”[i]ncreasing ‘extortion’-inducing ‘rents’ produces only one thing: more extortion!” Our leaders seemed to have understood this at one time. Lessig recalls that 30 ago, Senator John Stennis, chairman of the Armed Services Committee, balked at hosting defense contractors at a fundraiser. “Would that be proper?” Stennis asked. “I hold life and death over those companies. I don’t think it would be proper for me to take money from them.” By 2006, however, Senator Chuck Hagel observed that “We’ve blown past the ethical standards, we now play on the edge of the legal standards.”

In his new book, Throw Them All Out, Peter Schweizer argues that the only reason politicians have not blown past legal standards as well is because, as the ones who write the legal standards, they’ve made themselves exempt. Congress imposes conflict-of-interest rules on everyone in the executive and judicial branches of the federal government. But Schweizer reports that the House’s 400-page ethics manual and the Senate’s 500 page manual “are silent on the matter of inside trading” when it comes to Congress. He provides example after example of members of Congress, both Republican and Democrat, who engage in substantial stock trading at the same time they negotiate pending legislation concerning the very companies whose stock they trade. In the private sector, we call this insider trading. When Nancy Pelosi heavily invested in natural gas IPOs at the same time she championed federal legislation favoring the development of natural gas, she told Tom Brokaw, “That’s the marketplace.” In the real marketplace, however, the average American investor underperforms the market. The average corporate insider trading his own company’s stock and the average hedge fund outperforms the market by about 7%. The average U.S. senator, however, outdoes them all, beating the market by a stunning 12%. When Washington insiders talk about “the marketplace,” then, they’re speaking a different language.

Oddly, Lessig is reluctant to dole out blame for legislators’ perverse motives. Yielding to special interests “isn’t selling out,” he reasons. “It is surviving.” Congress passes laws with “sunset” provisions and “tax extenders” in order to drum up donations from laws’ supporters when expiration draws near. “For every time a ‘targeted tax benefit’ is about to expire,” Lessig explains, “those who receive this benefit have an extraordinarily strong incentive to fight to keep it.” Lessig notes that in the 1990s, there were fewer than a dozen tax extenders in the U.S. tax code. Now there are more than 140. Because the average legislator cannot stand up to special interests and still draw enough contributions for the next reelection campaign, Lessig contends, can we really blame them for playing along?

But the dog wags his own tail, too. Schweizer describes how members of Congress use “juicer bills” or “milker bills” to extort campaign contributions and favors from businesses and individuals. For example, Schweizer recalls that in 2006, Senate Majority Leader Harry Reid “announced that he wanted a tax hike on hedge funds,” and the following January, after Democrats captured both houses, “Senator Charles Schumer sat down to dinner with a number of top hedge fund managers” whose net worth totaled more than $100 billion. According to the New York Times, hedge funds were not significantly involved in lobbying or campaign spending until that time—typically well less than $2 million per year. After being “juiced” by Senators Reid and Schumer, however, hedge funds more than tripled their lobbying and campaign spending, clocking in at more than $6 million in 2007 and more than $7 million in 2008.

Legislators also deliberately create rents by limiting entry to economic activity, granting monopolies, restricting corporate charters, imposing tariffs, quotas, and regulations, and so on. By creating these rents, legislators form coalitions with rent-seekers who express their support through campaign contributions. This crony capitalism—not partisan politics or rigid ideology—explains American political dysfunction. “Our tax system is an abysmal inefficient mess not because of idiots at the IRS or on the Joint Committee on Taxation,” Lessig explains, “but because crony capitalists pay top dollar to distort the system to their benefit.” For the same reason, real financial reform remains out of reach so long as the government remains invested in protecting bloated banks. And real health care reform was impossible where “insurance companies and pharmaceutical companies had the power to veto any real change to the insanely inefficient status quo.”

Notably, Lessig expresses a brutal indignation for one politician who vowed, more earnestly and persuasively than any other in recent memory, to confront the breach of trust in Washington. This message earned space on millions of Americans’ bumpers and carried on the lips of many otherwise jaded young people. Now on the back nine of his term, Obama is “an opportunity missed”; “a bad joke”; “the last straw”; and, worst of all, “conventional.” As a further insult, Democrats have been aped by the Tea Party as the vehicle of true reform. “Earmarks were blocked in the 2011 budget because the Tea Party insisted upon it,” Lessig concedes. “There is an Office of Congressional Ethics, the only independent watchdog ensuring that members live up to the ethical rules, because the Tea Party insisted upon it.” To Lessig’s chagrin, this is not a message his compatriots on the left are ready to hear.

The motive and opportunity problem is structural. The motives of special interests are not problematic because they are illegal or unethical (though they are immoral). They are problematic because they are based in human nature and thus intractable. Just as water always flows downhill, the motives of special interests will always flow toward rational self-interest. These motives become problematic where the opportunities to promote self-interest are procedurally unjust. Blaming special interests or self-interest for the corruption in American politics makes no more sense than blaming rain for a leaky roof. The solution in both instances is structural: Fix the structure so as to prevent the intractable force of nature from flowing where it does not belong. In the case of special interests, this means ensuring political opportunities are procedurally fair by breaking up concentrations of political power and carefully constraining government’s power over economic transactions.

Concentrations of power draw special interests into politics. The larger the concentration of power, the more overwhelming the demand. When the average legislator represents a relatively small number of constituents and a relatively small share of the economy—i.e., where the concentration of power is low—rents tend to decrease. Like any other valuable resource, political power responds to supply and demand.

Consider the nature of the “supply” of power in D.C. Congress’s 535 members wield power over more than 300 million Americans—including their wealth-producing activity. Responsible for 30 volumes and 6,200 pages of statutes, and regulations consuming over 25 feet of shelf space, Congress presides over an annual economy well over $14 trillion. The average member of Congress wields power over a share of population of about 573,000 people, and a share of GDP worth more than $27 billion. Little surprise, then, that in 2010—the year the Supreme Court held in Citizens United that corporations had the same right to make independent campaign expenditures as individuals—independent expenditures tripled from 2006 to over $210 million. Focusing on the right to participate in the political process misses the point: it’s the incentives that matter.

Devolving basic governmental functions back to the states would go a long way toward breaking up the dangerous concentration of centralized power and curbing the destructive incentive to rent-seek. For example, Alaska—one of the 10 states for which independent expenditure data has been collected—is substantially more democratic than Congress. Alaska legislators represent on average fewer than 12,000 people and a share of about $760 million of the state’s total annual GDP. Iowa’s legislature is also relatively democratic: each state legislator represents about 20,000 people and about $980 million of GDP. Even less democratic states seem Athenian when compared to D.C. A vote in the state capital speaks for 43,000 people and $1.9 billion in Wisconsin; 45,000 and $2.4 billion in Washington; 50,000 and $2.6 billion in Colorado; 67,000 and $2.5 billion in Michigan; 71,000 and $2.9 billion in Arizona; and 117,000 and $4.7 billion in Florida. Special interest dollars invested in these states thus get substantially less mileage in these states than in D.C.

Conversely, the most undemocratic state in the union, California, fares even worse than D.C. in terms of political rent-seeking. Heavily concentrated Sacramento governs both the nation’s largest population and largest economy, yet has the 16th smallest legislature: The average vote purports to speak for a staggering 310,000 people and a $16 billion share of GDP.

These numbers matter when stacked up against independent political expenditure dollars. In 2010, independent expenditures in Alaska were less than $4 million—about $62,000 per legislator. In Iowa, the number is even more modest at about $40,000 per legislator. In power-concentrated Sacramento, by contrast, independent expenditure dollars flood in at a rate of more than $1 million per legislator. Note that in the chart below, the states are arranged left-to-right according to the population per legislator (per the graph above):

Rent-seeking thus becomes more aggressive where political institutions are less democratic. The centralization of power in legislatures like those in D.C., California, and Florida empowers lobbying and campaign dollars and creates influence-buying opportunities too good for special interests to pass up.

Rent-seeking opportunities are also tightly correlated with activist regulatory policy. In June 2011, George Mason University’s Mercatus Center published its Index of Personal and Economic Freedom, ranking the 50 states according to the impact of their respective regulatory landscapes. States with pervasive labor regulations, health-insurance coverage mandates, strict occupational licensing requirements, weak limits on eminent domain, and other negative impacts on economic liberty and property rights are given a lower score on the index. The rankings are indicated in the graph as follows:

Using the Mercatus Center’s regulatory freedom ranking, the trend in independent expenditures tilts decidedly upwards as regulatory impact increases:

Rent-seeking tracks regulatory intensity. This is not an indictment of the merits of the regulations, of course. For purposes of the exercise, we can assume that the regulatory landscapes of Florida, Colorado, Alaska, and California—the states with both the highest reported independent expenditures per capita and among the least regulatory freedom—were crafted with scrupulous dedication to the public interest. But it is special interests’ motives, not the lawmakers’, that matter. Again, Lancaster had no desire to condemn 99 Cents. Yet this did not deter Costco from leveraging ill-defined government power against it. And recall the political game Lessig describes that legislators must play: simplifying the law, removing tax extenders, and other measures in the public interest deprive politicians from much needed fundraising opportunities.

Similarly, there is no reason to assume the New Deal’s massive expansion of government programs was the result of anything but good intentions. This does not change the fact that, as Peter Schweizer points out, the Export-Import Bank is now known as “Boeing’s Bank,” devoting almost 40% of its entire $21 billion annual business in 2008 alone to that single special interest. We could also stipulate that the U.S. Fish and Wildlife Service and the EPA are charged with important work. Not that this matters to special interests. According to Schweizer, “states with House members on the budget oversight subcommittee responsible for funding the U.S. Fish and Wildlife Service and the Environmental Protection Agency had significantly fewer listings than other states,” and “‘Congressional representatives who sit on the Interior subcommittee of the House Appropriations Committee use their position to shield their constituents, at least partially, from the adverse consequences of ESA.’” Similarly, according to one study, “the IRS actually shifts enforcement away from congressional districts represented by legislators who sit on committees with oversight of the IRS.”

Centralization makes our democratic institutions less democratic, making fewer representatives responsible for the fate of greater shares of the economy and the population. This decline makes it easier for special interests to buy influence. The pressures of this influence lead lawmakers to engage in policymaking designed as much to elicit campaign dollars as to benefit the public. This conflicted-interest policymaking results in more opportunities for rent-seekers to buy or extract further political influence. Decentralization of federal power and returning governance to states and local governments will increase the democratic function of legislative institutions and make it more difficult and expensive to buy influence. States like California and Florida with poor democratic representation can increase the number of state legislators to make rent-seeking a more expensive proposition. These measures would substantially dry up opportunities for crony capitalism, and direct special interests’ profit motive to the marketplace where it belongs.

Regulatory reform, on the other hand, can only be achieved by the courts restoring the original understanding with respect to economic liberty. Even assuming pure motives on the part of a state legislature, the very fact that courts defer to its judgment on matters of economic and property rights creates opportunity for special interests to achieve their profit-driven motives through political influence rather than the market.

Modern movements demanding more government action in response to concentrations of wealth get the problem exactly backwards. Corruption and cronyism are fundamentally the result of concentrations of political power, which give special interests inexpensive one-stop shopping. For this reason did Montesquieu approvingly observe that the separation of government powers “should naturally form a state of repose or inaction.” Every act and agency of government taxes the people not only of their property and freedom, but of their trust in their democratic institutions. We must ask, then, whether the progressive new business government is charged to conduct is worth the increased corruption that will be transacted through the back door.

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