Crony Capitalism and Financial System Stability

Prior to the Asian financial crisis, the cozy relationships between corporations, governments, and banks were seen as a potent force for economic growth and development. In this article we examine the institution of crony capitalism. Under conditions in which the Second Welfare Theorem does not hold, there is a role for government. Some governmental institutions do encourage more risky, high‐payoff entrepreneurial activities. Our aim is to examine crony capitalism as a potential source of government activity that enhances economic productivity. In addition, we explore the conditions under which the government activity can instigate a financial crisis.