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Rent-seeking

In public choice theory, rent-seeking is the attempt to obtain economic rent through a deployment in the political, social or environmental landscape in which the economic activities seeks to occur. This is different to the value-adding approach of creating new sources of wealth. One example is spending money on political lobbying in order to be given a share of wealth that has already been created. A famous example of rent-seeking is the limiting of access to lucrative occupations, as by medieval guilds or modern state certifications and licensures. People accused of rent seeking typically argue that they are indeed creating new wealth (or preventing the reduction of old wealth) by improving quality controls, guaranteeing that charlatans do not prey on a gullible public, and preventing bubbles.

Many current studies of rent-seeking focus on efforts to capture various monopoly privileges stemming from government regulation of a market. The term itself derives, however, from the far older practice of appropriating a portion of production by gaining ownership or control of land.

Contents

Description

A simple definition of rent seeking is spending resources in order to gain by increasing one's share of existing wealth, instead of trying to create wealth. The net effect of rent-seeking is to reduce total social wealth, because resources are spent and no new wealth is created. In a theoretical context, it is important to distinguish rent-seeking from profit-seeking. Profit-seeking in this sense is the creation of wealth, while rent-seeking is the use of social institutions such as the power of government to redistribute wealth among different groups without creating new wealth.[1] In a practical context, income obtained through rent-seeking may of course contribute to profits in the standard, accounting sense of the word.

Rent-seeking implies extraction of uncompensated value from others without making any contribution to productivity. The origin of the term refers to gaining control of land or other natural resources. An example of rent-seeking in a modern economy is political lobbying for government benefits or subsidies, or to impose regulations on competitors, in order to increase market share. Economists such as the chair of British financial regulator the Financial Services Authority Lord Adair Turner have argued that innovation in the financial industry is often a form of rent-seeking.[2][3]

Studies of rent-seeking focus on efforts to capture special monopoly privileges such as manipulating government regulation of free enterprise competition.[4] The term monopoly privilege rent-seeking is an often-used label for this particular type of rent-seeking. Often-cited examples include a lobby that seeks tariff protection, quotas, subsidies,[5] or extension of copyright law.[6]

Development of theory

The phenomenon of rent-seeking in connection with monopolies was first formally identified in 1967 by Gordon Tullock.[7] The expression rent-seeking was coined in 1974 by Anne Krueger.[8] The word "rent" does not refer here to payment on a lease but stems instead from Adam Smith's division of incomes into profit, wage, and rent.[9] Rent-seeking behavior is distinguished in theory from profit-seeking behavior, in which entities seek to extract value by engaging in mutually beneficial transactions.[10]

Critics of the concept point out that in practice, there may be difficulties distinguishing between beneficial profit-seeking and detrimental rent-seeking.[11] Often a further distinction is drawn between rents obtained legally through political power and the proceeds of private common-law crimes such as fraud, embezzlement and theft. This viewpoint sees "profit" as obtained consensually, through a mutually agreeable transaction between two entities (buyer and seller), and the proceeds of common-law crime non-consensually, by force or fraud inflicted on one party by another.

Rent, by contrast with these two, is obtained when a third party deprives one party of access to otherwise accessible transaction opportunities, making nominally "consensual" transactions a rent-collection opportunity for the third party.

The high profits of the illegal drug trade are considered rents by this definition, as they are neither legal profits nor the proceeds of common-law crimes. Taxi medallions are another commonly referenced example of rent-seeking. To the extent that the issuing of medallions constrains overall supply of taxi services (rather than ensuring competence or quality), forbidding competition by non-medallion taxis makes the otherwise consensual transaction of taxi service a forced transfer of wealth from the passenger to the medallion holder.

Rent-seeking often occurs as lobbying for economic regulations such as tariffs. Regulatory capture is a related concept which refers to collusion between firms and the government agencies assigned to regulate them, which is seen as enabling extensive rent-seeking behavior, especially when the government agency must rely on the firms for knowledge about the market.

The concept of rent-seeking would also apply to corruption of bureaucrats who solicit and extract ‘bribe’ or ‘rent’ for applying their legal but discretionary authority for awarding legitimate or illegitimate benefits to clients.[12] For example, tax officials may take bribes for lessening the tax burden of the tax payers.

In many market-driven economies, much of the competition for rents is legal, regardless of harm it may do to an economy. However, some rent-seeking competition is illegal – such as bribery, corruption, smuggling, and even black market deals. Anne Krueger concludes that, “empirical evidence suggests that the value of rents associated with import licenses can be relatively large, and it has been shown that the welfare cost of quantitative restrictions equals that of their tariff equivalents plus the value of the rents” [13]

Recent studies have shown that the incentives for policy-makers to engage in rent-provision is conditional on the institutional incentives they face with elected officials in stable high-income democracies the least likely to indulge in such activities vis-a-vis entrenched bureaucrats and/or their counterparts in young and quasi-democracies.[14]

Possible consequences

From a theoretical standpoint, the moral hazard of rent-seeking can be considerable. If "buying" a favorable regulatory environment is cheaper than building more efficient production, a firm may choose the former option, reaping incomes entirely unrelated to any contribution to total wealth or well-being. This results in a sub-optimal allocation of resources — money spent on lobbyists and counter-lobbyists rather than on research and development, improved business practices, employee training, or additional capital goods — which retards economic growth. Claims that a firm is rent-seeking therefore often accompany allegations of government corruption, or the undue influence of special interests.[15]

Rent-seeking may be initiated by government agents, such agents soliciting bribes or other favors from the individuals or firms that stand to gain from having special economic privileges, which opens up the possibility of exploitation of the consumer.[16] It has been shown that rent-seeking by bureaucracy can push up the cost of production of public goods.[17] It has also been shown that rent-seeking by tax officials may cause loss in revenue to the public exchequer.[12]

Mancur Olson traced the historic consequences of rent seeking in The Rise and Decline of Nations. As a country becomes increasingly dominated by organized interest groups, it loses economic vitality and falls into decline. Olson argued that countries that have a collapse of the political regime and the interest groups that have coalesced around it can radically improve productivity and increase national income because they start with a clean slate in the aftermath of the collapse. An example of this is Japan after World War Two. But new coalitions form over time, once again shackling society in order to redistribute wealth and income to themselves. However, social and technological changes have allowed new enterprises and groups to emerge in the past.[18]

Rent-seeking behavior, in terms of land rent, figures in Georgist economic theory, where the value of land is largely attributed to provision of government services and infrastructure (e.g., road building, provision of public schools, maintenance of peace and order, etc.) and the community in general, rather than resulting from the actions of any given landowner, in their role as mere titleholder. This role must be disaggregated from the role of a property developer, which need not be the same person, and often is not.

A study by Laband and John Sophocleus in 1988[19] estimated that rent-seeking had decreased total income in the USA by 45 percent. Ultimately, it is difficult to truly know the cost of rent-seeking, affirmed by both Dougan and Tullock. Rent-seekers of government-provided benefits will in turn spend up to that amount of benefit in order to gain those benefits, in the absence of, for example, the collective-action constraints highlighted by Olson. Similarly, taxpayers lobby for loopholes and will spend the value of those loopholes, again, to obtain those loopholes (again absent collective-action constraints). The total of wastes from rent-seeking is then the total amount from the government-provided benefits and instances of tax avoidance (valuing benefits and avoided taxes at zero). Dougan says that the “total rent-seeking costs equal the sum of aggregate current income plus the net deficit of the public sector." [20]

Mark Gradstein writes about rent-seeking in relation to public goods provision, and says that public goods are determined by rent seeking or lobbying activities. But the question is whether private provision with free-riding incentives or public provision with rent-seeking incentives is more inefficient in its allocation.[21]

Rent-seeking can also be quite costly to economic growth. This is due to the fact that high rent-seeking activity makes more rent-seeking attractive because of the natural and growing returns that one sees as a result of rent-seeking. Thus, rent-seeking is valued over productivity. In this case there are very high levels of rent-seeking with very low levels of output. Another reason rent-seeking may grow at the cost of economic growth is that public rent-seeking by the state can so easily hurt innovation. Ultimately, public rent-seeking hurts the economy the most because innovation is what drives economic growth.[22]

The economist Joseph Stiglitz has argued that rent-seeking is a large component of the causes of American income inequality through lobbying for Government policies that let the wealthy and powerful get income not as a reward for creating wealth but by grabbing a larger share of the wealth that would otherwise have been produced without their effort.[23] Piketty, Saez, and Stantcheva have analyzed international economies and their changes in tax rates to conclude that much of income inequality is a result of rent-seeking among wealthy tax payers.[24]

See also

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  • Bribery
  • Cartel
  • Client politics
  • Law of rent
  • Political corruption
  • Political economy
  • Software patent
  • Public choice theory
  • The Logic of Collective Action
  • Regulatory capture
  • White elephant

References

  1. ^ Conybeare, John A. C. (1982). “The Rent-Seeking State & Revenue Diversification,” World Politics, 35(1): 25-42.
  2. ^ Turner, Adair (19 April 2012). "SECURITISATION, SHADOW BANKING AND THE VALUE OF FINANCIAL INNOVATION". John Hopkins University. SCHOOL OF ADVANCED INTERNATIONAL STUDIES (THE ROSTOV LECTURE ON INTERNATIONAL AFFAIRS). Retrieved 10 January 2013. 
  3. ^ Turner, Adair (17 March 2010). "WHAT DO BANKS DO, WHAT SHOULD THEY DO AND WHAT PUBLIC POLICIES ARE NEEDED TO ENSURE BEST RESULTS FOR THE REAL ECONOMY?". CASS Business School: 27. Retrieved 10 January 2013. 
  4. ^ Feenstra, Robert; Taylor, Alan (2008). "International Economics". Worth Publishers, New York. ISBN 978-0-7167-9283-3
  5. ^ Charles Kershaw Rowley (1988). The Political economy of rent-seeking. Springer. p. 226. 
  6. ^ Lanier Saperstein (1997). "Copyrights, Criminal Sanctions and Economic Rents: Applying the Rent Seeking Model to the Criminal Law Formulation Process". The Journal of Criminal Law and Criminology (Northwestern University) 87 (4): 1470–1510. 
  7. ^ Tullock, Gordon (1967). "The Welfare Costs of Tariffs, Monopolies, and Theft". Western Economic Journal 5 (3): 224–232. doi:10.1111/j.1465-7295.1967.tb01923.x. 
  8. ^ Krueger, Anne (1974). "The Political Economy of the Rent-Seeking Society". American Economic Review 64 (3): 291–303. JSTOR 1808883. 
  9. ^ Kelley L. Ross. "Rent-Seeking, Public Choice, and The Prisoner's Dilemma". Retrieved 2007-02-11. 
  10. ^ Robert Schenk. "Rent Seeking". CyberEconomics. Retrieved 2007-02-11. 
  11. ^ Pasour, E.C. "Rent Seeking: Some Conceptual Problems and Implications". The Review of Austrian Economics. 
  12. ^ a b Chowdhury, Faizul Latif (2006). Corrupt Bureaucracy and Privatization of Tax Enforcement. Pathak Shamabesh, Dhaka. ISBN 984-8120-62-9. 
  13. ^ Krueger, Anne. O (1974). “The Political Economy of the Rent Seeking Society,” The American Economic Review, 64(3): 291-303.
  14. ^ Hamilton , Alexander (2013), Small is beautiful, at least in high-income democracies: the distribution of policy-making responsibility, electoral accountability, and incentives for rent extraction [1], World Bank.
  15. ^ Eisenhans, Hartmut (1996). State, class, and development. Radiant Publishers. ISBN 978-81-7027-214-4. 
  16. ^ Michael Dauderstädt, Arne Schildberg (editors), ed. (2006). Dead Ends of Transition: Rentier Economies and Protectorates. Campus Verlag. ISBN 978-3-593-38154-1. 
  17. ^ Niskanen, William (1971). Bureaucracy and Representative Government. Aldine-Atherton, Chicago. 
  18. ^ Mokyr, Joel and John V.C. Nye. 2007. Distributional Coalitions, the Industrial Revolution, and the Origins of Economic Growth in Britain. Southern Economic Journal, 74(1):50-70.
  19. ^ Leeson, Peter T. The Invisible Hook: The Hidden Economics of Pirates. Princeton University Press. 2009. p. 191.
  20. ^ Dougan, William R. (1991). “The Cost of Rent Seeking: Is GNP Negative?” Journal of Political Economy, 99(3): 660-664.
  21. ^ Gradstein, Mark (1993). “Rent Seeking and the Provision of Public Goods,” The Economic Journal, 103(420): 1236-1243.
  22. ^ Murphy, Kevin M., Andrei Shleifer, and Robert W. Vishny (1993). “Why is Rent-Seeking So Costly to Growth?,” The American Economic Review, 83(2): 409-414.
  23. ^ Stiglitz, Joseph E. (2012-06-04). The Price of Inequality: How Today's Divided Society Endangers Our Future (p. 32). Norton. Kindle Edition.
  24. ^ Piketty, Thomas, Emmanuel Saez, and Stefanie Stantcheva (2011), "Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities", CEPR Discussion Paper 8675, December.

Further reading

  • Krueger, Anne (1974). "The Political Economy of the Rent-Seeking Society". American Economic Review 64 (3): 291–303. JSTOR 1808883. 
  • Chowdhury, Faizul Latif (2006). Corrupt Bureaucracy and Privatization of Tax Enforcement (A Rent Seeking Bureaucracy ed.). Pathak Shamabesh, Dhaka. pp. 25–34. ISBN 984-8120-62-9. 
  • Tullock, Gordon (1987). "Rent seeking". The New Palgrave: A Dictionary of Economics. Palgrave Macmillan. vol. 4, pp.147–149. ISBN 0-333-37235-2. 
  • Tullock, Gordon (2005). The Rent-Seeking Society : The Selected Works of Gordon Tullock, Vol. 5. 

External links

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