Political Risk Brief
Fall 2019

Crony Cannibalism Threatens American Innovation

Introduction

Business leaders confront intensifying attacks from struggling competitors who defend market position by relying on government favoritism rather than investing in innovation.  The proliferation of “crony cannibalism” – market participants seeking to leverage policy to undermine competitors rather than offering superior value – threatens destructive consequences for American innovation and economic growth.

The Differentiation Dilemma

The universe of companies with significant resources to innovate, or acquire and deploy innovation, has increased markedly, in addition to the innovation of smaller companies and startups.  Among U.S. firms alone, the number of companies with revenues of more than $20 billion (2019 dollars) has multiplied nearly 30-fold since 1955, the first year the Fortune 500 list was released.1  A similar trend has unfolded internationally.2  Using these resources to innovate unquestionably has delivered tremendous value to consumers.  Research Fellow at Stanford University’s Hoover Institution Russ Roberts describes in his video “Let’s Party Like It’s 1973!” how measures of inflation do not take into account the vastly improved quality of goods.  While a 21-inch television cost $600 in the 1970s (adjusting for inflation), a television twice the screen size that has access to thousands of channels only costs $500 today. According to the American Enterprise Institute (AEI), televisions are nearly 100 percent more affordable today than a decade ago.4

The automotive sector provides impressive examples of innovation as well.  The most-purchased automobile in 1955 was the Chevrolet Bel Air, which cost between $18,000 and $24,000 (2019 dollars), accelerates from 0-to-60 mph in 12.3 seconds with the top engine option, and offers no computer technology.5  The equivalent vehicle in 2018, the Toyota Camry, cost between $24,000 and $36,000 (2019 dollars), boasts a 0-to-60 time of 5.8 seconds with the optional 301 horsepower V6, and offers the following additional features: adaptive cruise control; Bluetooth; anti-theft alarm; dual-zone automatic climate control; blind spot monitoring system; backup camera with dynamic predictive backup lines; proximity keyless entry with push-button start; panoramic glass roof with power tilt/slide moonroof; Qi-compatible wireless smartphone charging; head-up display; and an eight-inch touchscreen.6  Furthermore, the 1955 Chevrolet Bel Air travels 16.4 miles per gallon (MPG), while the 2018 Toyota achieves 29 MPG in city driving and 41 MPG on the highway.7  Perhaps most importantly, overall vehicle reliability and safety has improved dramatically in recent decades.  The cost of owning and operating a vehicle has declined by nearly 40 percent since 1950, while the rate of motor vehicle fatalities per 1,000 miles of road has nearly halved since the 1960s.8

Yet, even as corporations have responded to rising competition from multiplying large competitors by pursuing innovation, the rapidly expanding administrative state inhibits differentiation.  Regulation frequently incentivizes – and often compels – product standardization.  The auto sector offers a powerful example: more than 16,000 regulatory requirements have resulted in largely homogenized models.9   In 2018 ,Fiat Chrysler CEO Mike Manley acknowledged the combined challenge of both increasing competition and regulation: “I’m not saying we’ll not have challenges to overcome. The next five years will continue to be extremely challenging for our industry, with tougher regulations [and] intense competition.”10

Politics Emerges as the New Competitive Advantage

With regulatory requirements making product differentiation increasingly challenging, the private sector today engages the political arena with greater urgency.  As one study explored, lobbying spending climbed 77 percent in 20 years, more than doubling the 38 percent rise in the federal budget during the same period.11 Unsurprisingly, this spending in Washington, D.C. has occurred alongside a vast expansion in federal regulation: the pages of the Federal Register have increased more than 550 percent since 1955.12  These developments make political competition particularly attractive to major companies.

Cost effectiveness: Corporations often perceive greater ROI from political relationships than product differentiation made ever-more arduous by regulation and other varieties of political risk.  Consider the costs of pharmaceutical R&D – $60 billion in 2018 alone – relative to the industry’s lobbying spending, approximately $300 million that same year.13  Securing an advantage through politics commonly comes at a far lower cost and with fewer constraints than the rare innovation that achieves market-moving product differentiation.

Stealth: C-suites deploy political strategies in ways almost undetectable by competitors.  This covert quality enhances the possibility of securing a meaningful advantage.  SEC filings describe political consideration only in the broadest terms.  Therefore, sophisticated companies pursue rewards measured in the billions, while spending millions, and largely without the risk of competitors duplicating or countering the political activity in a meaningful timeframe.

Asymmetry: Certain corporations have proved particularly adept at imposing disproportionately burdensome regulatory costs on competitors.  Such efforts often employ rhetoric supporting consumer health and safety, with the costs rarely disclosed to policy makers or the public.  Moreover, companies enjoy far more latitude to differentiate public affairs strategies than products or services.

The Rise of Crony Cannibalism

Companies that adopt an exclusively defensive posture – that is, simply resisting the higher regulatory costs that competitors seek to impose – risk encouraging the political aggression of private-sector adversaries.  To establish deterrence, the targets must either expose the cronyism to inflict reputational damage and/or respond in kind.  In either scenario, the result unleashes multiplying escalations among a growing lattice of intra- and inter-industry competitors.  The cumulative costs of this political friction defy easy measurement, but nonetheless pose a potentially serious threat to growth over the long term.

CASE STUDY: THE TOBACCO INDUSTRY AND NICOTINE

The Tobacco Master Settlement Agreement (MSA) serves as a defining example of crony cannibalism.  As explained by Jonathan H. Adler, Roger E. Meiners, Andrew P. Morriss, and Bruce Yandle in the Yale Journal on Regulation, after years of contentious legal battles, “anti-smoking groups still wished to see increased federal regulation of cigarettes.  The cigarette industry was happy to go along, if such regulation would reinforce the constraints of the MSA, deflect further tort litigation, and preempt some state and local regulation.”14  The resulting Tobacco MSA intentionally created a cartel that made innovating new, safer products almost impossible.

Tellingly, alternatives to combustion cigarettes – in the form of e-cigarettes – were developed outside the United States.  As e-cigarettes emerged as a true competitive threat in the U.S. market, the very forces responsible for the 1998 Tobacco MSA conspired to undermine this new technology.  Recent news coverage has been dominated by more than 30 deaths associated with e-cigarettes used in ways not authorized by manufacturers, even as 480,000 Americans die every year from illness caused by combustion tobacco consumed as intended.15  As Jonathan H. Adler et al. concluded, “Even small reductions in the number of smokers or even in the amount of tobacco products that smokers consume would likely produce substantial gains for public health.  Yet e-cigarettes have been greeted with scorn.”16

Outlook

Crony cannibalism entangles a growing number of companies in political warfare, whether as attackers or defenders.  The political arms race among major U.S. companies tempts business leaders confronting vigorous competition and government-driven standardization to leverage regulation, rather than pursue innovation.  If current incentives persist, crony cannibalism threatens to consume the nation’s creative energies and devour economic growth.

1  Fortune 500 list, 1955, https://archive.fortune.com/magazines/fortune/fortune500_archive/full/1955/1.html; and Fortune 500 list, 2019 https://fortune.com/for- tune500/2019.

2  U.S. Bureau of Economic Analysis, “Corporate profits after tax: Rest of the world,” retrieved from FRED, Federal Reserve Bank of St. Louis, October 18, 2019, https:// fred.stlouisfed.org/series/A3274C0A144NBEA.

3  Russ Roberts, “Let’s Party Like It’s 1973!” POLICYed, September 10, 2019, https://www.policyed.org/numbers-game/lets-par ty-its-1973/video.

4  Mark J. Perry, “Chart of the day (century?): Price changes 1997 to 2017,” American Enterprise Institute, February 2, 2018, https://www.aei.org/carpe-diem/chart-of-the-day-century-price-changes-1997-to-2017.

5  “1955 Chevrolet Body Styles,” 1955 Classic Chevy, https://55classicchevy.com/1955-chevrolet-body-styles; and Christian Seabaugh, “Chevrolet’s Game-Changing Bel Air Won Our Hearts in 1955 … and Today,” Motor Trends, July 9, 2019, https://www.motortrend.com/news/ultimate-car-of-the-year-finalist-1955-chevrolet-bel-air-america. While some models may have been priced at below $18,000 in 2019 dollars, based on sales data, some models likely cost up to $24,000.

6  Alisa Priddle, “2018 Toyota Camry First Test Review: Big Improvement but is it Enough?” Motor Trends, November 13, 2017, https://www.motortrend.com/cars/toyota/camry/2018/2018-toyota-camry-first-test-review; and Joe Bruzek, “Which 2018 Toyota Camry Trim Should I Buy: L, LE, SE, XSE or XLE?” Cars.com, June 23, 2017, https://www.cars.com/articles/which-2018-toyota-camry-trim-should-i-buy-l-le-se-xse-or-xle-1420695891238.

7  “Chevrolet Bel Air MPG,” Fuelly, http://www.fuelly.com/car/chevrolet/bel_air; and “2018 Toyota Camry,” U.S. Department of Energy, Office of Energy Efficiency & Renewable Energy, https://www.fueleconomy.gov/feg/PowerSearch.do?action=noform&path=1&year1=2018&year2=2018&make=Toyota&baseModel=Camry&s-rchtyp=ymm.

8  Ellen Edmonds, “Driving Costs Hit Six-Year Low, Finds AAA,” American Automobile Association, April 7, 2016, https://newsroom.aaa.com/2016/04/driving-costs-hit-six-year-low-finds-aaa-2; and Federal Highway Administration, “Motor Vehicle Traffic Fatalities, 1900 – 2015, National Summary,” Department of Transportation, 2015, https://www.fhwa.dot.gov/policyinformation/statistics/2015/pdf/fi200.pdf.

9  Patrick A. McLaughlin and Oliver Sherouse, “RegData U.S. 3.1 Annual (dataset),” QuantGov, Mercatus Center at George Mason University, https://quantgov.org/regda-ta-us.

10 Mike Manley, “FCA CEO Issues letter to Employees,” Fiat Chrysler Automobiles, October 1, 2018, https://www.fcagroup.com/en-US/media_center/fca_press_re-lease/2018/october/Pages/FCA_CEO_issues_letter_to_employees.aspx.

11  Lee Drutman, “The Business of America is Lobbying: Explaining the Growth of Corporate Political Activity in Washington, D.C.,” Penn State University, 2010, https://tech-liberation.com/wp-content/uploads/2012/12/business_of_america_is_lobbying.pdf.

12 “Federal Register Pages Published Annually,” Law Librarians’ Society of Washington, D.C., https://www.llsdc.org/assets/sourcebook/fed-reg-pages.pdf.

13  “2019 PhRMA Annual Membership Survey,” PhRMA, July 17, 2019, https://www.phrma.org/-/media/Project/PhRMA/PhRMA-Org/PhRMA-Org/PDF/PhRMA_2019_membership_survey_Final.pdf; and Karl Evers-Hillstrom, “Lobbying spending reaches $3.4 billion in 2018, highest in 8 years,” Center for Responsive Politics, January 25, 2019, https://www.opensecrets.org/news/2019/01/lobbying-spending-reaches-3-4-billion-in-18.

14  Jonathan H. Adler, Roger E. Meiners, Andrew P. Morriss, and Bruce Yandle, “Baptists, Bootleggers & Electronic Cigarettes,” Yale Journal on Regulation, Volume 33, Issue 2 (2016): 313-361, https://digitalcommons.law.yale.edu/cgi/viewcontent.cgi?article=1487&context=yjreg.  This study includes full disclosure of corporate funding.

15  “Outbreak of Lung Injury Associated with E-Cigarette Use, or Vaping,” Centers for Disease Control and Prevention, October 10, 2019, https://www.cdc.gov/tobacco/basic_information/e-cigarettes/severe-lung-disease.html; “Smoking & Tobacco Use: Fast Facts,” Centers for Disease Control and Prevention, February 6, 2019, https://www.cdc.gov/tobacco/data_statistics/fact_sheets/fast_facts/index.htm; and Justin Kirkland, “The Director of the CDC Says the Vaping Crisis Stats Are Just the ‘Tip of the Iceberg’,” Esquire, October 9, 2019, https://www.esquire.com/lifestyle/health/a29343883/vaping-illness-epidemic-cdc-director-interview.

16  Jonathan H. Adler, Roger E. Meiners, Andrew P. Morriss, and Bruce Yandle, ibid.