Rent-seeking

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Rent-seeking is a concept in public choice theory as well as in economics, that involves seeking to increase one's share of existing wealth without creating new wealth. Rent-seeking results in reduced economic efficiency through misallocation of resources, reduced wealth-creation, lost government revenue, heightened income inequality, [1] and potential national decline.

Contents

Attempts at capture of regulatory agencies to gain a coercive monopoly can result in advantages for the rent seeker in a market while imposing disadvantages on their incorrupt competitors. This is one of many possible forms of rent-seeking behavior.

Regulatory capture is a form of government failure which occurs when a regulatory agency, created to act in the public interest, instead advances the commercial or political concerns of special interest groups that dominate the industry or sector it is charged with regulating. When regulatory capture occurs, the interests of firms, organizations, or political groups are prioritized over the interests of the public, leading to a net loss for society. Government agencies suffering regulatory capture are called "captured agencies."

In economics and business ethics, a coercive monopoly is a firm that is able to raise prices, and make production decisions, without risk of competition arising to draw away their customers. A coercive monopoly is not merely a sole supplier of a particular kind of good or service, but it is a monopoly where there is no opportunity to compete with it through means such as price competition, technological or product innovation, or marketing; entry into the field is closed. As a coercive monopoly is securely shielded from possibility of competition, it is able to make pricing and production decisions with the assurance that no competition will arise. It is a case of a non-contestable market. A coercive monopoly has very few incentives to keep prices low and may deliberately price gouge consumers by curtailing production. Also, according to economist Murray Rothbard, "a coercive monopolist will tend to perform his service badly and inefficiently."

Description

The idea of rent-seeking was developed by Gordon Tullock in 1967, [2] while the expression rent-seeking itself was coined in 1974 by Anne Krueger. [3] The word "rent" does not refer specifically to payment on a lease but rather to Adam Smith's division of incomes into profit, wage, and rent. [4] The origin of the term refers to gaining control of land or other natural resources.

Gordon Tullock American economist

Gordon Tullock was an economist and professor of law and Economics at the George Mason University School of Law. He is best known for his work on public choice theory, the application of economic thinking to political issues. He is one of the founding figures in his field.

Adam Smith 18th-century Scottish moral philosopher and political economist

Adam Smith was a Scottish economist, philosopher and author as well as a moral philosopher, a pioneer of political economy and a key figure during the Scottish Enlightenment, also known as ''The Father of Economics'' or ''The Father of Capitalism''. Smith wrote two classic works, The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776). The latter, often abbreviated as The Wealth of Nations, is considered his magnum opus and the first modern work of economics. In his work, Adam Smith introduced his theory of absolute advantage.

In economics, profit in the accounting sense of the excess of revenue over cost is the sum of two components: normal profit and economic profit. All understanding of profit should be broken down into three aspects: the size of profit, the portion of the total income, and the rate of profit. Normal profit is the profit that is necessary to just cover the opportunity costs of the owner-manager or of the firm's investors. In the absence of this profit, these parties would withdraw their time and funds from the firm and use them to better advantage elsewhere. In contrast, economic profit, sometimes called excess profit, is profit in excess of what is required to cover the opportunity costs.

Georgist economic theory describes rent-seeking in terms of land rent, where the value of land largely comes from government infrastructure and services (e.g. roads, public schools, maintenance of peace and order, etc.) and the community in general, rather than from the actions of any given landowner, in their role as mere titleholder. This role must be separated from the role of a property developer, which need not be the same person.

Rent-seeking is an attempt to obtain economic rent (i.e., the portion of income paid to a factor of production in excess of what is needed to keep it employed in its current use) by manipulating the social or political environment in which economic activities occur, rather than by creating new wealth. Rent-seeking implies extraction of uncompensated value from others without making any contribution to productivity. The classic example of rent-seeking, according to Robert Shiller, is that of a feudal lord who installs a chain across a river that flows through his land and then hires a collector to charge passing boats a fee (or rent of the section of the river for a few minutes) to lower the chain. There is nothing productive about the chain or the collector. The lord has made no improvements to the river and is not adding value in any way, directly or indirectly, except for himself. All he is doing is finding a way to make money from something that used to be free. [5]

In economics, economic rent is any payment to an owner or factor of production in excess of the costs needed to bring that factor into production. In classical economics, economic rent is any payment made or benefit received for non-produced inputs such as location (land) and for assets formed by creating official privilege over natural opportunities. In the moral economy of neoclassical economics, economic rent includes income gained by labor or state beneficiaries of other "contrived" exclusivity, such as labor guilds and unofficial corruption.

In business, the difference between the sale price and the production cost of a product is the unit profit. In economics, the sum of the unit profit, the unit depreciation cost, and the unit labor cost is the unit value added. Summing value added per unit over all units sold is total value added. Total value added is equivalent to revenue less intermediate consumption. Value added is a higher portion of revenue for integrated companies, e.g., manufacturing companies, and a lower portion of revenue for less integrated companies, e.g., retail companies. Total value added is very closely approximated by compensation of employees plus earnings before taxes. The first component is a return to labor and the second component is a return to capital. In national accounts used in macroeconomics, it refers to the contribution of the factors of production, i.e., capital and labor, to raising the value of a product and corresponds to the incomes received by the owners of these factors. The national value added is shared between capital and labor, and this sharing gives rise to issues of distribution.

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 or corruption.

Rent-seeking is distinguished in theory from profit-seeking, in which entities seek to extract value by engaging in mutually beneficial transactions. [6] Profit-seeking in this sense is the creation of wealth, while rent-seeking is "profiteering" by using social institutions, such as the power of the state, to redistribute wealth among different groups without creating new wealth. [7] In a practical context, income obtained through rent-seeking may contribute to profits in the standard, accounting sense of the word.

Profit, in accounting, is an income distributed to the owner in a profitable market production process (business). Profit is a measure of profitability which is the owner’s major interest in income formation process of market production. There are several profit measures in common use.

Tullock paradox

The Tullock paradox is the apparent paradox, described by Tullock, on the low costs of rent-seeking relative to the gains from rent-seeking. [8] [9]

The paradox is that rent-seekers wanting political favors can bribe politicians at a cost much lower than the value of the favor to the rent-seeker. For instance, a rent seeker who hopes to gain a billion dollars from a particular political policy may need to bribe politicians only to the tune of ten million dollars, which is about 1% of the gain to the rent-seeker. Luigi Zingales frames it by asking, "Why is there so little money in politics?" because a naive model of political bribery and/or campaign spending should result in beneficiaries of government subsidies being willing to spend an amount up to the value of the subsidies themselves, when in fact only a small fraction of that is spent.

Possible explanations

Several possible explanations have been offered for the Tullock paradox: [10]

  1. Voters may punish politicians who take large bribes, or live lavish lifestyles. This makes it hard for politicians to demand large bribes from rent-seekers.
  2. Competition between different politicians eager to offer favors to rent-seekers may bid down the cost of rent-seeking.
  3. Lack of trust between the rent-seekers and the politicians, due to the inherently underhanded nature of the deal and the unavailability of both legal recourse and reputational incentives to enforce compliance, pushes down the price that politicians can demand for favors.

Examples

Antichristus, a woodcut by Lucas Cranach the Elder, of the pope using the temporal power to grant authority to a ruler contributing generously to the Catholic Church PapalPolitics2.JPG
Antichristus, a woodcut by Lucas Cranach the Elder, of the pope using the temporal power to grant authority to a ruler contributing generously to the Catholic Church

An example of rent-seeking in a modern economy is spending money on lobbying for government subsidies in order to be given wealth that has already been created, or to impose regulations on competitors, in order to increase market share. [12] Another example of rent-seeking is the limiting of access to lucrative occupations, as by medieval guilds or modern state certifications and licensures. Taxi licensing is a textbook example of rent-seeking. [13] To the extent that the issuing of licenses constrains overall supply of taxi services (rather than ensuring competence or quality), forbidding competition from other vehicles for hire renders the (otherwise consensual) transaction of taxi service a forced transfer of part of the fee, from customers to taxi business proprietors.

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. [14] For example, tax officials may take bribes for lessening the tax burden of the taxpayers.

Regulatory capture is a related term for the 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. Studies of rent-seeking focus on efforts to capture special monopoly privileges such as manipulating government regulation of free enterprise competition. [15] 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 economic regulations such as tariff protection, quotas, subsidies, [16] or extension of copyright law. [17] 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". [18]

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. [19] [20]

Development of theory

The phenomenon of rent-seeking in connection with monopolies was first formally identified in 1967 by Gordon Tullock. [21]

A 2013 study by the World Bank showed 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-à-vis entrenched bureaucrats and/or their counterparts in young and quasi-democracies. [22]

Criticism

Critics of the concept point out that, in practice, there may be difficulties distinguishing between beneficial profit-seeking and detrimental rent-seeking. [23]

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.[ citation needed ]

Possible consequences

From a theoretical standpoint, the moral hazard of rent-seeking can be considerable. If "buying" a favorable regulatory environment seems 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, on improved business practices, on employee training, or on 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. [24]

Rent-seeking can prove costly to economic growth; 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 organizations value rent-seeking over productivity. In this case there are very high levels of rent-seeking with very low levels of output.[ citation needed ] Rent-seeking may grow at the cost of economic growth because rent-seeking by the state can easily hurt innovation. Ultimately, public rent-seeking hurts the economy the most because innovation drives economic growth. [25]

Government agents may initiate rent-seeking – 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. [26] It has been shown that rent-seeking by bureaucracy can push up the cost of production of public goods. [27] It has also been shown that rent-seeking by tax officials may cause loss in revenue to the public exchequer. [14]

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. [28]

A study by Laband and John Sophocleus in 1988 [29] estimated that rent-seeking had decreased total income in the USA by 45 percent. Both Dougan and Tullock affirm the difficulty of finding the cost of rent-seeking. 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". [30]

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. [31]

The Nobel Memorial Prize-winning economist Joseph Stiglitz has argued that rent-seeking contributes significantly to income inequality in the United States 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. [32] [33] Thomas Piketty, Saez, and Stefanie 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. [34]

See also

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References

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  11. Passional Christi und Antichristi Full view on Google Books
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Further reading