Rent-seeking

In public choice theory, rent-seeking is spending wealth on political lobbying to increase one's share of existing wealth without creating wealth. The effects of rent-seeking are reduced economic efficiency through poor allocation of resources, reduced wealth creation, lost government revenue, national decline, and income inequality.

Current studies of rent-seeking focus on the manipulation of regulatory agencies to gain monopolistic advantages in the market while imposing disadvantages on competitors. The term itself derives, however, from the far older practice of gaining a portion of production through ownership or control of land.

Description

The expression rent-seeking was coined in 1974 by Anne Krueger.^[1] 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.^[2] The origin of the term refers to gaining control of land or other natural resources.

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, and often is not.

Rent-seeking is an attempt to obtain economic rent, (i.e., the portion of income paid to a factor of production in excess of that which 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.

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.

Rent-seeking is distinguished in theory from profit-seeking, in which entities seek to extract value by engaging in mutually beneficial transactions.^[3] 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.^[4] In a practical context, income obtained through rent-seeking may of course contribute to profits in the standard, accounting sense of the word.

Examples

An example of rent-seeking in a modern economy is spending money on political lobbying for government benefits or subsidies in order to be given a share of wealth that has already been created, or to impose regulations on competitors, in order to increase market share.

A famous 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 commonly-referenced example of rent-seeking. To the extent that the issuing of licenses constrains overall supply of taxi services (rather than ensuring competence or quality), forbidding competition by livery vehicles, unregulated taxis and/or illegal taxis 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.^[5] For example, tax officials may take bribes for lessening the tax burden of the tax payers.

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. Studies of rent-seeking focus on efforts to capture special monopoly privileges such as manipulating government regulation of free enterprise competition.^[6] 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,^[7] or extension of copyright law.^[8] 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” ^[9]

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.^[10][11]

Development of theory

The phenomenon of rent-seeking in connection with monopolies was first formally identified in 1967 by Gordon Tullock.^[12]

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.^[13]

Criticism

Critics of the concept point out that in practice, there may be difficulties distinguishing between beneficial profit-seeking and detrimental rent-seeking.^[14]

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.

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.

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 can also be 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, 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.^[16]

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.^[17] It has been shown that rent-seeking by bureaucracy can push up the cost of production of public goods.^[18] It has also been shown that rent-seeking by tax officials may cause loss in revenue to the public exchequer.^[5]

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.^[19]

A study by Laband and John Sophocleus in 1988^[20] 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." ^[21]

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.^[22]

The economist Joseph Stiglitz has argued that rent-seeking is a large contributor 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.^[23][24] 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.^[25]

Public policy response

Limitations on, and taxation of, rent-seeking is popular in the U.S. with large segments of both Republicans and Democrats.^[26]

See also

• Bribery
• Cartel
• Client politics
• Competition law
• For-profit education
• Landed gentry
• Law of rent
• Political corruption
• Political economy
• Public choice theory
• Regulatory capture
• Software patent
• The Logic of Collective Action
• White elephant

References

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

• Rent-Seeking, The Economist
• Henderson, David R. (2008). "Rent Seeking". Concise Encyclopedia of Economics (2nd ed.). Indianapolis: Library of Economics and Liberty. ISBN 978-0865976658. OCLC 237794267. 
• Rent-Seeking as Process by Mushtaq Khan

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