Business, Legal & Accounting Glossary
A close friend who accompanies his buddies in their activities
Crony literally means a longtime friend. Crony capitalism refers to a capitalist market structure, where businessmen and ruling government share a close relationship. Laissez-faire is not the sole determinant of the success of a business enterprise in crony capitalism. Businessmen form lobbies to extract favouritism from the ruling party. Favouritism accrues in the form of government grants, tax breaks and various financial incentives. It is argued that political parties and business enterprises form a kind of symbiotic relationship to stay in power via the creation of networks. Both parties reap positive gains from cooperation.
Suppose one starts with an economic model/system devoid of cronies. For simplicity, the banking industry is assumed to be perfectly competitive. Now project owners borrow loans from banks. Here representative banks, as well as borrowers, are risk-neutral. An equilibrium loan contract will fund only those investment projects, which have positive expected NPV values. Here, representative banks do not bear bankruptcy risks and earn zero profits.
Now let the crony system be introduced in this market framework. Suppose, the ruling government provides a guarantee of a portion of a crony’s loan repayments, in event of a project failure. [A crony project owner is entitled to pecuniary benefits as well as some potential non-pecuniary benefits. Government guarantees provided to cronies are not part of any formal legislative directive]. Banks write ‘crony-specific’ loan contracts for this purpose and its own capital is put at risk for ensuring solvency.[Bank’s normally cannot diversify away risks arising from crony lending]. In this type of market setup financial crisis becomes a simple fallout of a government’s inability to honour concerning guarantees.
Some key observations from this study have been summarized below.
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This glossary post was last updated: 4th April, 2020 | 26 Views.