The Privileged Position Of Business: An Evaluative Essay

By

Todd Julie

For

Professor Rodney Haddow

POL224

T.A. Gabriel Arsenault

Mar.13, 2012

“Charles Lindblom argues that business’s ‘privileged position’ means that it has a powerful impact on governments even without using interest groups to press home its arguments. The story about banking and financial regulation in the US very much reflects this ‘structural’ kind of influence. The financial sector does not use well-financed interest groups to push home its preferences in Washington. In spite of how much weak financial regulation contributed to the economic crisis of 2008, however, financial interests have blocked any meaningful steps towards greater regulation of that sector in the US.”

The above statement rests on the major premise that (1) government advancement of big

business interests is structurally embedded within the decision making process. The

argument also rests on the assumptions that (2) business did not significantly lobby in

advance of the new financial government legislation . . . And (3) that it is in the interest

of business to minimize new regulations. Taking all this for granted, it is asserted that (4)

the government privileged business interests in the crafting of its post-crises legislation,

without a signifigant lobbying effort by the business community. This paper will argue

that while Lindblom’s assessment of structural business power is convincing, despite

being problematic in certain ways, the above statement is deeply flawed. Other scholars

have argued that business influence is more in the key of a negotiation, with business’s

voice at the table waxing and waning with the times. This view is lent support by the fact

that big business did lobby extensively in the post-crisis period. Further while the

business community in general fights against new regulations, there do exist divisions

within that community. These divisions present opportunities that, while small, may

allow governments to escape the “structural” influence of business, in the face of strong

public opposition to that sector. In fact the degree to which government privileged

business in the crafting of post-crisis legislation is highly debatable.

What are the structural mechanisms that Lindblom asserts work in business's favour?

Between his book Politics and Markets and the proscribed article, he mentions three main

factors. The first is what he terms an "automatic punishing recoil"1. What this means is

that without any conscious plot on the part of dissatisfied business leaders, their

disapproval registers in the form of scaled back business initiatives and smaller job

1 Lindblom, C., “The Market As Prison.” in The Journal Of Politics, Vol. 44 (1982): 325

creation. This manifest disapproval acts as punishment of a consequently less prosperous

electorate that will then hold politicians accountable for reduced economic prospects.

The threat alone of electoral retribution is usually enough to persuade politicians of the

rightness of the business perspective. In May 2011, the New York Times did report poll

results showing Americans more downbeat than anytime since President Obama had

taken office, in the face of bad economic times2.

But is it a given that the electorate will hold politicians responsible? Another recent

article illustrates that with the President trying to portray Republicans as the “defenders

of a small elite”3 and Republicans trying to highlight Obama’s supposedly “failed

stewardship of the economy”4, there is more than one explanation available to voters for

an ailing economy. Bernhagen & Brauninger point to findings (Mitchell, 1997, pp. 41-

59; Smith, 2000, pp. 167-96) that in certain instances, the business community fails to get

its way. These mixed results lead Bernhagen & Brauninger to put forward a "signal

theory"5 where legislation is negotiated by both sides according to competing cost-benefit

calculations done by both sides. The electoral impetus for government officials to be

seen as fulfilling their ideological pledges acts as a counterweight to Lindblom's

"automatic punishment recoil" (they don't use the specific term)6. There has been a

strong public outcry against business in the wake of the economic crisis, prompting the

2 Harwood, J. “Organizing Now, Democrats Expect Tough Bid in 2012” New York Times, May 2, 2011: A18. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/864180234?accountid=147713 Sulzberger, A. “Obama Sounds A Populist Call On G.O.P. Turf” New York Times, Dec.7, 2011: A1. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/908705228?accountid=147714 Ibid.5 Bernhagen, P. and Brauninger, T. “Structural Power And Public Policy: A Signaling Model Of Business Lobbying In Democratic Capitalism” in Political Studies Vol. 53 (2005): 436 Ibid., 48

Obama administration’s attempt to position the President as “defender of the middle

class”7. Echoing this suggestion of legislative cost balancing is a further suggestion by

Helleiner & Pagliari that, in light of the crisis, more "cyclical theories of private influence

in which booms encourage deregulation, followed by crises and re-regulation"8 may have

to be developed. The suggestion is that business influence is more contingent on the

continuing goodwill of legislators and the public at large than prior literature on the topic

would indicate.

The second mechanism, of which Lindblom takes especial note, in his book Politics and

Markets, is "constitutional rules - especially the law of private property” which “specifies

that, although governments can forbid certain kinds of activity, they cannot command

business to perform. They must induce rather than command"9. This principle does seem

to have been at work during the financial crisis. Phillip Swagel, a treasury assistant

secretary during the crisis, later wrote of the generous share price paid by the government

to invest in failing banks "the government had to offer attractive terms because it could

not force the banks to agree to any investment"10. He went on to say that many of the

policy prescriptions put forward by "academic economists"11 would run into legal

constraints and further, "A lesson for academics is that anytime they use the verb "force"

(as in "The policy should be to force banks to do X or Y"), the next sentence should set

7 Dewan, S. and Gebeloff, R. “One Percent, Many Variations” New York Times, Jan. 15, 2012: A1. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/915983265?accountid=147718 Helleiner, E. and Pagliari, S. “The End Of An Era In International Financial Regulation? A Postcrisis Research Agenda” in International Organization 65, Winter (2011): 1809 Lindblom, C. Politics And Markets (New York, NY: Basic Books Inc, 1977), 17310 Johnson, S. and Kwak, J. 13 Bankers: The Wall Street Takeover And The Next Financial Meltdown (New York, NY: Pantheon Books, 2010), 15511 Swagel, P. “The Financial Crisis: An Inside View” in Brookings Papers On Economic Activity Vol. 2009 (Spring 2009): 2

forth the section of the U.S. legal code that allows that course of action"12. The Dodd-

Frank legislation has indeed run into legal challenges, stemming from a 1996 law that

"requires the S.E.C. to promote ‘efficiency, competition and capital formation’. The law

enabled the financial industry to build lawsuits around the economic costs of a rule,

regardless of its merits"13. Margaret E. Tahyar, a partner at the law firm Davis Polk

explains the banking industry’s approach to the Dodd-Frank legislation package: "There

is no reasonable constitutional or statutory challenge on the whole - only on the bits and

pieces."14. What Ms. Tahyar is describing is the familiar 'death by a thousand cuts'

approach. The appeals court has tossed out three financial regulations in the last six

years.

The third structural mechanism, according to Lindblom, is corporate law, specifically

limited liability. A recent article in The New York Times discussing the willingness of

private versus public companies to indemnify executives against potential lawsuits

illustrates Lindblom's point perfectly. In the case of a public company, where

shareholders pay the cost, executives are indemnified to a great extent against any

potential legal repercussions resulting from their actions. The article cites two examples:

"Bank of America, in its acquisition of Countrywide, agreed to indemnify . . . for any

claim brought without regard to whether he had acted in bad faith. JPMorgan Chase

agreed to a similar provision for . . . executives and directors in the Bear Stearns deal.

12 Ibid., 313 Protess, B., “Court Ruling Offers Path To Challenge Dodd-Frank” New York Times, Aug. 18, 2011:B1. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/884106659?accountid=1477114 Ibid.

This is a startlingly broad indemnification, which the courts have upheld."15. Apparently

executives at private equity firms don't fare as well. This is what allowed individuals in

the banking industry to walk away from the crisis they created with relative ease, leaving

government officials to clean up the mess. Limited liability greatly strengthens big

finance's hand in negotiating any possible regulation of their industry with government

officials. Johnson & Kwak recount how, "In the end the government had more to lose

from major bank failures than did the bankers"16. They describe how bank heads were

able to "take a large chunk of the economy hostage" and "dictate the terms of their

rescue", secure in the knowledge that they "had already made their money"17.

Apart from Lindblom’s stated three mechanisms, business also exercises a normative

power over government - monopoly over technical financial expertise18. Because finance

officials are apparently the only ones who understand the complexities of the economy,

there tends to be a revolving door between elite finance positions and government

regulatory appointments19. A shared culture makes it extremely difficult for legislators to

think about the national interest as separate from those of the large banks. Pagliari's

findings, that despite a technical shift in the form of financial regulations after the crises,

from private to public, their remains a great deal of continuity between pre and post-crisis

regulations, in terms of their content20, illustrate clearly the character of this normative

15 Davidoff, S. “DEAL PROFESSOR; For Executives Seeking Absolution, A Double Standard” New York Times, No. 24, 2010: B5. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/808431949?accountid=1477116 Johnson & Kwak, 13 Bankers, 18417 Ibid., 18418 Ibid., 93-9419 Ibid., 18520 Pagliari, S. “Who Governs Finance?: The Shifting Public-Private Divide In The Regulation Of Derivatives, Rating Agencies And Hedge Funds” in European Law Journal Vol. 18, No. 1, (2012):

influence. In 2008, when crafting the initial bank bailout, the Bush administration stated

it would only hire “people with expertise in asset management, accounting and legal

issues” and would “outsource the bulk of the program to 5 to 10 asset management

firms”21. Governments have the authority to make laws but are hesitant to stray from the

line laid down by economists. However this normative power of economists is itself

checked, according to Bernhagen & Brauninger, by a "reputational cost"22 associated with

lying. If financial representatives or lobbyists are seen to provide false information, they

will cease to be trusted by policy makers in the future23.

Despite the manifold evidence of structural influence enjoyed by the financial sector, the

claim that business does not need to lobby government officials is undermined by the fact

that they do lobby, intensively. The financial sector mounted an impressive lobbying

effort in advance of post-crisis legislation. The Los Angeles Times reported that

"Lobbying expenditures jumped 12% from 2008 to $29.8 million last year {2009} among

the eight banks and private equity firms that spent the most to influence legislation"24 and

expected that figure to be even higher in 201025. In 2012, lobbying against the Volker

rule, which would prevent banks from proprietary trading ("placing bets with their own

money"26), has been unprecedented. "I've never seen a rule-making response like this

21 Lander, M. and Andrews, E.L. “Bailout Wins Approval; Democrats Vow Tighter Rules” New York Times, Oct.4, 2008: A1. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/433957730?accountid=1477122 Bernhagen & Brauninger, “Structural Power And Public Policy: A Signaling Model Of Business Lobbying In Democratic Capitalism” in Political Studies Vol. 53 (2005): 4723 Ibid., 4724 Popper, N. “Wall Street; Banks Hike Lobbying Spending: Spending jumped 12% Last Year Over 2008 As Financial Firms Fought Regulatory Proposals” Los Angeles Times Feb. 16, 2010: B1. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/422295201?accountid=1477125 Ibid.26 Protess, B. & Eavis, P. “At Volker Rule Deadline, A Strong Pushback From Wall St.” New York Times, Feb. 14, 2012: B4. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/921284927?

before,"27 said Derek M. Bush, a lawyer at Cleary Gottlieb who helped Draft letters to

legislators on behalf of financial interests28. To be fair to Lindblom, he does not, in his

book Politics & Markets, deny the existence of lobbyists, as implied in the initial

statement above.

Despite this intensive lobbying, it is unclear that de-regulation or less regulation is even

in the financial industry's larger interest. The crisis has revealed a diverse set of interests

within the financial community, not all of whom, regard increased regulation negatively.

Helleiner and Pagliari explain these divisions:

"During the financial crisis, quite sharp divisions emerged among different parts of the private financial sector, divisions that reduced the sector’s overall influence. Banks demanded tighter regulation of credit-rating agencies against these agencies’ wishes. Accountants and banks strongly disagreed with each other about the need to reform market-to-market accounting. Investors and exchanges criticized the reluctance of derivatives dealers and brokers to accept tighter regulation of over-the-counter derivatives. In some cases, these divisions reflected efforts by individual sectors to shift the blame for the crisis and the regulatory burden upon other sectors. In other cases, certain parts of the financial industry recognized material gains they could realize from regulatory tightening in specific areas. The disagreements also reflected different lessons learned from the crisis and distinct judgments about the long-term interests of the financial industry. These developments suggest the need for future theorizing to disaggregate the industry into its constituent parts and to embrace more context-specific analyses of financial industry preferences"29

Bernhagen & Brauninger cite a somewhat ambiguous statement by Birnbaum (1984) that

financial interests will generally try to reduce regulatory uncertainty30. Reducing

regulatory uncertainty need not immediately be equated with reducing regulation itself.

accountid=1477127 Ibid.28 Ibid.29 Helleiner & Pagliari, “The End Of An Era In International Financial Regulation? A Postcrisis Research Agenda” in International Organization 65, Winter (2011): 17930 Bernhagen & Brauninger, “Structural Power And Public Policy: A Signaling Model Of Business Lobbying In Democratic Capitalism” in Political Studies Vol. 53 (2005): 46

However, they assert that it will lead to business approaching regulation from a generally

conservative viewpoint31. While there may be disagreement among different parts of the

financial sector, the lobbying statistics mentioned above, along with one reform group’s

claim that “of the substantive responses (to the Volker rule) 13 were pro-reform,

compared with 300 from the industry”32, suggest this generally conservative viewpoint is

still a largely held one, despite the financial crisis.

Whether or not the government unduly privileged business interests in the crafting of its

post-crisis legislation is difficult to assess. As discussed above, Wall Street has mounted

a fierce lobbying campaign to influence the legislation process. On the other hand, the

2008 crisis created widespread popular distrust of Wall Street. Popular dissent and

protest have arguably opened a small space for government to escape the ideological

constraints of Wall Street. Here we should bear in mind both Bernhagen & Brauninger's

"reputational cost"33, incurred by politicians who are seen to back away from their

previous ideological stance and Helleiner & Parliari's call for a more cyclical theory of

private influence34. Legislators have passed Dodd-Frank, enacted a consumer protection

agency and are in the process of trying to institute the "Volker rule". However, the merit

of these measures is debatable. Johnson & Kwak criticize Dodd-Frank for not going far

enough and tackling the problem of "too big to fail" financial institutions35. An article in

31 Ibid., 4632 Eisinger, J. “The Volker Rule, Made Bloated And Weak” New York Times, Feb.23, 2012: B4. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/922734032?accountid=1477133 Bernhagen & Brauninger, “Structural Power And Public Policy: A Signaling Model Of Business Lobbying In Democratic Capitalism” in Political Studies Vol. 53 (2005): 4734 Helleiner, E. and Pagliari, S. “The End Of An Era In International Financial Regulation? A Postcrisis Research Agenda” in International Organization 65, Winter (2011): 18035 Johnson & Kwak, 13 Bankers,191

the economist complaining about the length and complexity of Dodd-Frank gave two

reasons for that complexity: hubris (American legislators thinking they can regulate every

imaginable scenario) and lobbying, which the article asserts leads to lengthy bills that

allow those in congress to "slip in clauses that benefit their chums and campaign donors"

and makes it easy for business to find loopholes36. The idea being that the length of

Dodd-Frank is an indicator of lobbyist influence. In light of the Bernhagen and

Brauninger piece37, this leads to the possible paradox that the influence of individual

business interests negatively affects the aggregate desire of business to simplify it's

regulatory environment. If correct, this would lend further support to Helleiner and

Pagliari's call for a more diverse, less monolithic conception of business interests38.

It is hard to argue against the proposition that big finance exerts a structural influence on

government. Constitutional and corporate law tend to facilitate such an influence.

Although Lindblom's "automatic punishing recoil" is not as singular an influence on

government as it’s made to seem. It can be checked by democratic outrage in extreme

circumstances. Only this can explain the continued lobbying on behalf of financial

institutions. Still, it is debatable whether or not it is in the interest of the financial system

as a whole to block the new regulations. All of this renders the statement quoted at the

outset of this paper deeply problematic. Though I find the sentiment of it much harder to

fault than its substance.

36 The Economist, “Over-regulated America: United States’ Economy,” Feb. 18, 2012: http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/922240698?accountid=1477137 As mentioned above, the authors describe how business will act to simplify it’s regulatory environment., Bernhagen & Brauninger, “Structural Power And Public Policy: A Signaling Model Of Business Lobbying In Democratic Capitalism” in Political Studies Vol. 53 (2005): 4638 Helleiner, E. and Pagliari, S. “The End Of An Era In International Financial Regulation? A Postcrisis Research Agenda” in International Organization 65, Winter (2011): 179

Bibliography

Books & Scholarly Articles

1. Lindblom, C., “The Market As Prison.” in The Journal Of Politics, Vol. 44 (1982)

2. Bernhagen, P. and Brauninger, T. “Structural Power And Public Policy: A Signalling Model Of Business Lobbying In Democratic Capitalism” in Political Studies Vol. 53 (2005)

3. Helleiner, E. and Pagliari, S. “The End Of An Era In International Financial Regulation? A Postcrisis Research Agenda” in International Organization 65, Winter (2011)

4. Lindblom, C. Politics And Markets (New York, NY: Basic Books Inc, 1977)

5. Swagel, P. “The Financial Crisis: An Inside View” in Brookings Papers On Economic Activity Vol. 2009 (Spring 2009)

6. Johnson, S. and Kwak, J. 13 Bankers: The Wall Street Takeover And The Next Financial Meltdown (New York, NY: Pantheon Books, 2010)

7. Pagliari, S. “Who Governs Finance?: The Shifting Public-Private Divide In The Regulation Of Derivatives, Rating Agencies And Hedge Funds” in European Law Journal Vol. 18, No. 1, (2012)

Newspaper & Magazine Articles

1. Harwood, J. “Organizing Now, Democrats Expect Tough Bid in 2012” New York Times, May 2, 2011: A18 (http:)

2. Dewan, S. and Gebeloff, R. “One Percent, Many Variations” New York Times, Jan. 15, 2012: A1 (http)

3. Protess, B. “Court Ruling Offers Path To Challenge Dodd-Frank” New York Times, Aug. 18, 2011:B1 (http)

4. Davidoff, S. “DEAL PROFESSOR; For Executives Seeking Absolution, A Double Standard” New York Times, No. 24, 2010: B5 (http)

5. Popper, N. “Wall Street; Banks Hike Lobbying Spending: Spending jumped 12% Last Year Over 2008 As Financial Firms Fought Regulatory Proposals” Los Angeles Times Feb. 16, 2010: B1 (http)

6. Protess, B. & Eavis, P. “At Volker Rule Deadline, A Strong Pushback From Wall St.” New York Times, Feb. 14, 2012: B4 (http)

7. The Economist, “Over-regulated America: United States’ Economy,” Feb. 18, 2012

8. Sulzberger, A. “Obama Sounds A Populist Call On G.O.P. Turf” New York Times, Dec.7, 2011: A1. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/908705228?accountid=14771

9. Eisinger, J. “The Volker Rule, Made Bloated And Weak” New York Times, Feb.23, 2012: B4. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/922734032?accountid=14771

10. Lander, M. and Andrews, E.L. “Bailout Wins Approval; Democrats Vow Tighter Rules” New York Times, Oct.4, 2008: A1. http://ezproxy.qa.proquest.com.myaccess.library.utoronto.ca/docview/433957730?accountid=14771