The Economic Consequences of State Capture

Oligarchs Are Warping Markets and Corrupting Economies Around the World – By Elizabeth David-Barrett

Since returning to office, U.S. President Donald Trump and his benefactor, the tech billionaire Elon Musk, have taken a chainsaw to the government. In just over three months, Musk has purged agencies of staff, replaced fired workers with loyalists, and canceled existing public contracts—including for completed work. Trump, meanwhile, has fired inspectors general and removed the head of the Office of Government and Ethics. Together, the two men have taken resources that Congress had appropriated, abusing the power of the purse to redirect funds toward themselves and away from their perceived opponents. The Trump administration has ordered more Musk-made Starlink satellite dishes and put Musk’s companies, already some of the government’s biggest clients, in the running for billions more in contracts. At the same time, Trump has canceled government funding for universities and law firms that don’t support his agenda.

To most Americans, this kind of corruption will seem unfamiliar. Never in modern U.S. history has a businessman president partnered with the world’s wealthiest man to seize control of the federal government. But globally, it is part of a worrying pattern. In struggling democracies around the world, small cliques of politicians, business elites, and politicians with business interests—what political scientists call “poligarchs”—have warped the state to serve their interests. Together, these unholy alliances change rules, fire bureaucrats, silence critics, and then eat up the country’s resources. The politicians commandeer banks, rewrite regulations, and take control of procurement contracts. Their friends in the private sector, meanwhile, provide kickbacks, donations, and favorable media coverage.

There is a name for this process: state capture. It has occurred in Bangladesh, Hungary, South Africa, Sri Lanka, Turkey, and many other countries. Its exact economic effects can be difficult to quantify, and it often takes years before they fully manifest. But they are serious. In captured economies, the relationship between talent and success is severed. Skilled workers who lack the right political connections leave the country, and competent firms go under. Well-networked firms, meanwhile, grow fat without innovating or delivering quality products (or, sometimes, without delivering products at all). The country’s infrastructure deteriorates. Banks run out of money giving bad loans to favored businesses. The result is lower growth, fewer jobs, rising inequality, and high inflation.

Unfortunately, resisting and reversing state capture is an arduous process. It requires that whistleblowers, journalists, and activists continuously speak up, with no immediate reward and at significant personal risk. Such persistence can pay off in the long run: civil society groups in Bangladesh, South Africa, and Sri Lanka eventually chased out corrupt politicians. But success often comes only after captors have crashed the economy by milking it for everything it’s worth. And by then, rebuilding is extremely difficult.

THE ART OF THE STEAL

In captured countries, no sector is safe from political interference. But banks are especially at risk. Financial firms, after all, provide an economy with capital and facilitate transactions—both of which are essential to theft. In Bangladesh, for example, former Prime Minister Sheikh Hasina used her control over banks to loot at least $17 billion from the country, according to Bangladesh’s interim government. In Malaysia, former Prime Minister Najib Razak financed a variety of crony schemes by delivering government-backed bonds to allied companies through 1MDB, a state development bank. Those firms, in turn, gave Najib’s party funding. A cool $700 million found its way to his personal accounts. Turkish President Recep Tayyip Erdogan forces state-owned banks to lend more to local mayors who support him. Those mayors then use the funds for spending projects that help them and Erdogan win elections.

Politicians deploy any number of measures to seize control of a country’s financial institutions. In Turkey, Erdogan used his executive authority to appoint allies to state-owned banks. Najib created 1MDB from scratch, to act as his personal fiefdom. In Hungary, Prime Minister Viktor Orban used a complicated scheme involving buying and selling discounted bank shares to secure control of his country’s largest private financial firm. And according to Ahsan Mansur, the governor of the central bank in Bangladesh, Hasina had the country’s military intelligence forces kidnap and threaten bank directors and board members to force them to sell their shares to her oligarch friends.

The economic toll of this kind of takeover can be devastating. Most obviously, it siphons billions of dollars out of a country’s economy: Najib, for example, used 1MDB to loot $4 billion from the Malaysian state (one percent of the country’s GDP), and Hasina may have looted up to $30 billion (seven percent of Bangladesh’s GDP). But the capture of banks corrodes markets in more insidious ways, as well. Banks have only so much money to give to companies, so when they lend on the basis of political connections, they forgo opportunities to extend credit to healthy or promising firms. Sometimes, they even run out of money lending to well-connected companies. Ordinary people then lose their deposits, and a financial crisis ensues. In Sri Lanka and Turkey, the result was extreme inflation, as the government kept printing money to cover budget deficits. (Turkey also refused to raise interest rates, in hopes of spurring continued economic growth.)

Captors dismantle bodies that might check their efforts.

State captors, of course, do not constrain their manipulations to banks. They also change the government’s economic policies and regulations. In Sri Lanka, governments led by members of the Rajapaksa family, which dominated the country from 2005 to 2022, slashed tariffs on sugar imports, effectively giving a trading company close to them a huge tax break. It worked: the company sold its stocks of cheaply imported sugar without cutting prices, reaping massive profits. But the country’s revenues took a major hit, losing a sum of money equivalent to 1.3 percent of Sri Lanka’s tax revenues for 2021.

In other cases, captors simply exempt favored firms from regulations. Former Tunisian President Zine el-Abidine Ben Ali and his family, for instance, owned companies that imported consumer goods such as cars and electronics, and so they should have had to pay a lot in tariffs. But his government allowed politically connected firms to evade such taxes with impunity. As a result, the Ben Ali family earned huge profits. Companies without connections, meanwhile, had to pay—putting them at a disadvantage and exacerbating inequality.

Such exemptions are illegal. But captors take care to dismantle whatever bodies might investigate them or otherwise check their efforts. In South Africa, former President Jacob Zuma, who led the country from 2009 to 2018, partnered with Ajay, Atul, and Rajesh Gupta—three businessmen brothers—to try to take down the South African Revenue Service. As a body, SARS was highly respected for investigating tax evasion and financial crime, and in 2013, the Guptas received a tip that they were under scrutiny. But in 2014, Zuma appointed a loyal commissioner who purged the agency’s management. He brought in consultants to recommend a restructuring that destroyed SARS’s ability to carry out investigations. Meanwhile, to limit political blowback, the Guptas used their newspaper and television station to run a smear campaign undermining SARS’s reputation.

For Zuma and the Guptas, these efforts were a success. A hobbled SARS ditched its investigation into the Guptas’ companies. But the gutting of the institution proved terrible for South Africa. Since the restructuring, SARS has significantly undershot its revenue collection targets, resulting in cuts to spending on much-needed infrastructure.

HIGHWAY ROBBERY

Not every act of state capture is complex. Sometimes, oligarchs just steal directly from the state. Erdogan, for example, changed Turkey’s public procurement law multiple times so that he could personally dictate the outcome of tenders. He has since used this power to channel government business to five conglomerates, which are among the world’s ten most successful companies at winning public contracts. In exchange, these businesses, many of which own media properties, have showered the Turkish president with favorable news coverage, donated to charities run by his party, and pressured their employees to vote for Erdogan.

South Africa provides another case in point. Under Zuma, the Gupta brothers won contract after contract and used their connections to extract kickbacks from other firms. Having started with a small-time computer company, they soon had a multibillion-dollar business that was involved in sectors as varied as dairy, management consulting, and coal. They exercised enormous influence over Zuma’s government, choosing people he appointed to key cabinet roles and selecting the leaders of state-owned enterprises. The Guptas, in turn, channeled funds into Zuma’s pocket and pumped out pro-Zuma propaganda.

Corruption like this further suppresses growth. In a healthy economy, companies compete on quality and price. But in captured ones, firms succeed by forging the right relationships, giving them little incentive to innovate or be efficient. Some of the best companies lose out simply because they lack the right networks. Would-be entrepreneurs don’t bother starting businesses. Many skilled workers leave the country in search of markets in which talent, not proximity to power, is rewarded. Favored companies, meanwhile, overcharge and underdeliver. Economic output, in turn, declines. Quality of life worsens. Sometimes, people even lose their lives. According to multiple studies, the 2023 Turkish earthquake would have been less deadly if the country’s infrastructure had been better. But it wasn’t—because Erdogan had protected the construction companies who built it from competition and oversight.

The capture of South Africa’s state electricity provider, Eskom, offers another vivid illustration of how corruption causes damage. Eskom was once a star in its sector; it was voted the world’s leading power company at the 2001 Financial Times Global Energy Awards. It faced a big task in the 1990s and early years of the 2000s: to maintain its standards while extending electricity to the half of South African households that had not had access to it under apartheid. But the Guptas’ influence vastly exacerbated Eskom’s challenges. Under Zuma, Eskom was forced to buy coal from the Gupta family rather than on the open market. The Guptas were thus free to bill at exorbitant rates and deliver a poor-quality product. The brothers made a fortune, but Eskom now struggles to supply energy to South Africans, who must contend with daily blackouts. According to an estimate by the South African Treasury, failings at Eskom and another state-owned company, the railway operator Transnet, have shaved around 30 percent off South Africa’s economy over the last 15 years.

Eventually, these economic troubles cause problems for state captors. There is, after all, only so much money they can steal. But poligarchs rarely change course as markets collapse. Instead, they ride the economy into the ground, stealing from it until it fails. In Sri Lanka, for example, the Rajapaksas’ theft drove the debt-to-GDP ratio to 114 percent in 2022, triggering a balance-of-payments crisis that caused chronic shortages of fuel, food, and medicine. Inflation hit 49 percent. But President Gotabaya Rajapaksa and his brother, who served as prime minister, maintained tax breaks for cronies. They introduced controls on the purchase of foreign currency but granted friends continued access to dollars. They could have defaulted and asked the International Monetary Fund for a bailout, which might have allowed ordinary Sri Lankans to again buy essential goods. But instead, they kept paying back bonds, which were owned by their affiliates. (Sri Lanka eventually defaulted anyway.)

NO EASY FIX

Unless they govern full-blown autocracies, poligarchs do have to contend with opposition. Even flawed democracies have institutions that try to hold executive power to account. Courts reverse unlawful decisions, auditing bodies uncover fraud, and journalists expose corrupt deals. Brave people risk everything to blow the whistle on misconduct. Sometimes, they take to the streets in protest. But power-grabbing leaders push on regardless, and they usually succeed at avoiding accountability. State capture, after all, effectively ensures that the most powerful people in the country are the captors. They have the most money and control over the political apparatus.

Sometimes, however, the opposition succeeds. Hasina, Rajapaksa, and Zuma were eventually booted from office. But all too often, captors are evicted only after the economy is in deep trouble. In Sri Lanka, it took months of shortages and soaring prices before protesters were able to oust the Rajapaksas. In Bangladesh, demonstrators toppled Hasina after she tried to direct even more government jobs to allies. But by then, the country’s economy was ravaged. Today, the banking system is on the verge of collapse, with people unable to withdraw their deposits and thus buy even basic goods.

It is hard for states to recover from such extensive damage. New leaders struggle to patch the vast economic holes left by stolen assets because their ruined economies have no obvious tax base. The financial system is in tatters, so they struggle to borrow, as well. They can try to go after the poligarchs who hold much of this stolen wealth. But frequently, those elites now live abroad. The ones that remain have squirreled away their assets offshore, making it difficult for the state to collect what they owe.

The best way to address state capture is to avoid it.

Rebuilding state institutions is even more challenging. New leaders may want to purge the bureaucracy, but mass firings would look like a tit for tat, and they would gut institutions of needed staff. As a result, leaders have to take a slow-and-steady approach to reconstruction—which, for a time, means continuing to pay corrupt officials. Likewise, to avoid further devastation, new governments find they must keep paying corrupt companies. Societies need certain resources—food, water, power, medicine—and after years of capture, it takes time to find suppliers who are not the incumbents. Before new businesses enter the market, they have to be convinced that tenders are no longer rigged and that it is thus worth their time to bid for contracts.

The best way to address state capture, then, is to avoid it from the start. But unfortunately for Americans, Trump and Musk’s takeover is well underway. Years passed before Zuma granted the Guptas unfettered access to his administration; Trump gave it to Musk on his first day in office. The U.S. bureaucracy has already lost thousands of workers, and thousands more are at risk. Critical regulatory agencies, including the Federal Communications Commission and the Federal Trade Commission, are now led by Trump loyalists. The Internal Revenue Service has yet to be ravaged as SARS was, but Trump and Musk have made it clear the agency is in their cross hairs. So is the Federal Reserve. And Trump has staffed the FBI and the Department of Justice with favorites he hopes will go after his enemies.

If Trump and Musk succeed at capturing the American economy, they will not only distort U.S. markets. They will harm economies the world over. Since the United States is the planet’s largest economy and its main financial node, what happens there reverberates everywhere. And traditionally, Washington has been the world’s most powerful force for clean governance, pressuring and sanctioning corrupt elites elsewhere. But Trump has moved to suspend enforcement of the Foreign Corrupt Practices Act and backtrack on corporate transparency requirements. The United States, in other words, is not just abandoning its historical role as the world’s clean-governance policeman. It is changing sides and becoming a mob boss. It is turning into a very different kind of role model.

[ForeignAffairs]