Crony capitalism tipped for a comeback

The end of rampant globalisation which fuelled the rise of China, and a return to local manufacturing and service provision, will bring its own set of problems, including a forecast rise in business and government corruption.

Flashes of what that means have been seen in a number of recent prosecutions of civil servants working for the Western Australian Government in seemingly innocuous roles in the public health system and other areas of government.

But if Macquarie Bank is right in its deep dive into the effects of transition from a globally focused system to one turning in on itself, then it might be wise for management of private companies to tighten internal controls and carefully monitor dealings with government.

The core of the Macquarie thesis, published in a research note with the obscure title of Local exposure v QSG (quality sustainable growth) and Thematics, is that a rapid transfer of financial power to the state, which is being accelerated by government money creation to try and ward off the worst effects of COVID-19, is creating get-rich-quick temptations.

Boiled down, government has emerged as the richest player in the economy and is splashing the cash, which means queues of people with their hands out have formed at the front and back doors of every department where staff lacking experience in handling money are being taken for a ride – or arranging a ride for themselves.

The JobKeeper and JobSeeker programs are prime examples of government unleashing its spending power without carefully thinking through how the system should work, whether there are enough staff to administer it, and whether the right people are getting the money.

Macquarie has looked at the changes flowing from the rise of the state, and tried to identify “investable” themes, a tricky task which came down to a question of separating “crony capitalism and good localisation”.

“The world is fracturing, and it is becoming more localised,” Macquarie said in the report, which defined crony capitalism as a term describing an economy in which “success in business depends on close relationships between businesses and government officials”.

WA’s worst previous experience of crony capitalism was during the 1980s when a number of businessmen such as Alan Bond, Laurie Connell and Robert Holmes a Court worked too closely with the state government.

Macquarie said crony capitalism was normally seen as a problem in poor countries but there was ample evidence of “rent-seeking behaviour” in developed countries, especially the US.

But the bombshell in the bank’s analysis was a claim that not all crony capitalism is bad.

“Some degree of corruption is actually good for any economy as it lubricates transactions and helps resolve disputes,” Macquarie said, before adding that a problem arises when crony capitalism raises monopolistic rents to the point that it seriously retards economic development.

It is highly unlikely many people will readily accept Macquarie’s point about a little bit of corruption not being a bad thing, just as they do not accept that the Curate was telling the truth in the famous Punch cartoon in 1895 about a clergyman describing his rotten boiled egg as being “excellent, in parts”.

The bank’s advice for investors is that the global changes under way, including the rise of state spending, create challenges in finding high-quality investment opportunities, if only because of greater state control and aggressive changes in tax policy and government regulations.

“One of the side effects of COVID-19 is that we have moved from a theoretical discussion of pros and cons into real-world applications, with permanent fiscal expansion going mainstream,” the bank said.

This sea change in the economy could mean that the most profitable investments over the next few years will be a lot closer to home than at any time over the past 40 years, when China led the rush to globalise.

Macquarie said one of its themes over the past three years had been the need to identify local companies which benefited from increased spending by Australian governments.

However, unlike the pursuit of companies able to demonstrate QSG or theme-based portfolios (such as resources and banks), spotting local winners is more difficult because it requires local knowledge rather than simple awareness of broad trends.

Macquarie believes QSG will continue to rule as an investment approach, but some localisation might be needed.

“In order to play this theme, investors should look for companies that are largely locally based, employ local people, pay local taxes and have close ties to government, with operations broadly in line with state goal,” the bank said.

For anyone who lived through the disgraceful years of WA Inc, when government and business came close to morphing into one corrupt organism, the crony capitalism thesis is horrifying – but it could also be the next big thing, however rotten.