The news yesterday that several Ex-Im employees are under investigation for having potentially accepted “gifts and kickbacks, as well as attempts to steer federal contracts to favored companies” isn’t exactly surprising to me. Under the pretense of propping up U.S. exports through its different programs, the bank allocates capital based on politics. Unfortunately, political allocation of capital has two very negative, inevitable consequences: inefficiency and corruption.
Inefficiency: Economists have found that when capital is allocated by politicians, the decision to fund a certain project may be the product of political connections, promises of campaign contributions, or simply political preferences of the time (think about how so much money is redirected towards green-energy projects these days), rather than projects’ merits or their creditworthiness. In most cases, this process misdirects resources and leads to what economists call malinvestment. Policymakers and bureaucrats don’t have better information or even the incentives to acquire good information about what projects are worth funding. They’re not spending their own money, which isn’t conducive to the best investments. So they don’t pay enough attention to the signals that usually allow investors to base their decision on all of the widely diffused and rapidly changing knowledge conveyed by the price system.
At the firm level, subsidies like Ex-Im have very negative consequences for innovation and process-improvement, because firms tend to shift resources toward subsidized products away from more intrinsically worthy projects, and move their attention away from managing the business toward lobbying policymakers and influencing the bureaucracy. Over time, this leads to diminishing productivity gains, which in turn slows real income growth and reduces real GDP well below its potential.
Corruption: Political allocation of capital incentivizes both the politicians/bureaucrats and the company hoping for a handout to engage in corruption. First, a company may try to to secure funding by offering politicians and bureaucrats something they may want in exchange for being picked for a handout. But policymakers and bureaucrats may also be tempted to use their position of power to direct funding in ways that are contrary to to the standard set for the allocation in the first place — instead, based on friendship, political connections, or bribes.
My colleague Matthew Mitchell explains:
The problem is that objective standards for playing favorites are hard to come by. This can corrupt even well-intentioned programs that privilege particular behavior in the name of serving the general good.
Imagine you are a politician and you want to reward firms that specialize in renewable energy. How do you determine who makes the cut? What if you want to reward companies that securitize mortgages for low-income households. How do you decide whom to reward? Or say you want to bailout “systemically important” banks. Where do you draw the line between systemically important and systemically unimportant?
Without objective guideposts, subjective factors loom large: whom do you interact with the most? Whom have you known the longest? Which firms share your ideological perspective? Which are headquartered in your hometown?
Even the most well-intentioned of politicians are susceptible to these considerations because all humans are susceptible to these considerations. That’s why a slew of research has found government-granted privileges are often associated with corruption. For example, in anexamination of 450 firms in 35 countries, economists Mara Faccio, Ronald Masulis, and John McConnell found that politically connected firms are more likely to be bailed out than non-connected firms. It’s possible that more deserving firms just happen to be politically connected, but this strains credulity. A more plausible explanation is that in the absence of an objective standard for dispensing privileges, politicians reward those they know.
And when that is the case, firms make it their business to get to know politicians.
Don’t believe this happens? Just ask the Ex-Im Bank. As I mentioned, the Wall Street Journal reported yesterday that four of the bank’s employees have been removed in recent months amid allegations of kickbacks meant to steer money toward favored companies and other corruption.
The U.S. Export-Import Bank has suspended or removed four officials in recent months amid investigations into allegations of gifts and kickbacks, as well as attempts to steer federal contracts to favored companies, several people familiar with the matter said.
One employee, Johnny Gutierrez, an official in the short-term trade finance division, allegedly accepted cash payments in exchange for trying to help a Florida company obtain U.S. government financing to export construction equipment to Latin America, according to a person familiar with the inquiry. Mr. Gutierrez was escorted from the Ex-Im Bank building in April, said two people familiar with the matter. …
Of the four employees, Mr. Gutierrez’s responsibilities were most central to the agency’s core mission of financing exports. Two of the others are being investigated over allegations of improperly awarding contracts to help run the agency; the third is being investigated over allegations of accepting gifts on behalf of a company seeking financing, according to people familiar with the matter. The identities of the three couldn’t be fully corroborated. …
The IG is investigating whether Mr. Gutierrez accepted improper gifts from Gerardo “Jerry” Diaz, who runs a Florida company called Impex Associates, a person familiar with the matter said.
Multiple efforts to reach Mr. Diaz and Impex were unsuccessful. A lawyer who represented Mr. Diaz in a federal court case in 2006 said he no longer worked for Mr. Diaz and hadn’t represented him in years.
Impex ramped up its operations a decade ago, selling U.S. construction equipment and supplies to developers, mainly in Latin America, according to Ex-Im Bank records and the 2006 lawsuit filed against Mr. Diaz by a former business associate, Rama Vyasulu.
The agency has guaranteed numerous Impex deals, stretching back to at least 2002, according to agency records. For example, at one meeting in June 2007, the agency’s credit committee agreed to guarantee financing for an Impex project worth between $1 million and $5 million in Mexico, and a similarly sized equipment sale to the Dominican Republic.
The agency has also backed Impex deals in Jamaica and the Turks and Caicos, but not all projects were in Latin America. The agency in 2005 talked up its decision to guaranteea $30 million Impex construction project to build a housing community for oil and gas workers in Doha, Qatar.
As the Heritage Foundation’s Diane Katz reveals this morning, this is not an isolated event. “There have been at least 74 cases since April 2009 in which bank officials were forced to act on the basis of ‘integrity’ investigations by the Office of Inspector General,” she writes. “Dozens of other fraud cases involving Ex-Im beneficiaries have been referred to the Department of Justice for prosecution.” She has more information and details in the piece.
Worth mentioning too is this 2010 Bloomberg News piece, which exposed how “Exxon Mobil Corp. treated Export-Import Bank employees to first class accommodations and entertainment as they decided whether or not to approve a $15 billion project supported by Exxon,” as the Club for Growth summarized it this morning.
Unfortunately, these instances of corruption and mismanagement of taxpayer money are rarely exposed, since there are very strong incentives for other bureaucrats in the agency to cover it up. This problem isn’t unique to the Ex-Im Bank, obviously, but in this case the policy to fix the problem is simple: Take away the ability to bestow political favors by putting an end to whatever subsidies we let bureaucrats and politicians dole out. The answer certainly isn’t to allow bureaucrats to allocate even more money than they already do.