Rent-seeking

georgism

capture

Rent-seeking is attempting to take advantage of a pre-existing resource without improving it. According to Nobel Laureate economist Robert Shiller the classic example 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 helping nobody in any way, directly or indirectly, except himself. All he is doing is finding a way to make money from something that used to be free.

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.

In economic theory it is described as increasing one’s share of existing wealth without creating any new wealth. Rent-seeking results in reduced economic efficiency through poor allocation of resources, reduced actual wealth creation, lost government revenue, increased income inequality, and (potentially) national decline. Rent-seekers attempt to capture regulatory agencies (lobbying) to gain a coercive monopoly result in unfair disadvantages for competitors, diminishing trust in the marketplace. The idea was originated by lawyer and economist Gordon Tullock in 1967 and the term was coined in 1974 by former World Bank Chief Economist Anne Krueger.

The word ‘rent’ does not refer here to payment on a lease but stems instead from Scottish political economist Adam Smith’s division of incomes into profit (return to the proprietors of capital stocks), wage (return to labor), and rent (return to landowners). In classical economics rent was exclusively the return to an ‘owner’ of land, but in later economic theory the terms expanded to include other forms of unearned income typically realized from barriers to entry. Land ownership is considered to be a barrier to entry because land owners make no contribution to the production process. They simply prevent others from using that which would otherwise be useful.

Georgist economic theory holds that the economic value derived from natural resources and natural opportunities should belong equally to all residents of a community, but that people own the value they create. It 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.

Organizations are guilty of rent-seeking when they 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 or corruption.

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

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 (e.g. ‘protection rackets’). 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. Often-cited examples include a lobby that seeks economic regulations such as tariff protection, quotas, subsidies, or extension of copyright law. 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.’

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. 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-à-vis entrenched bureaucrats and/or their counterparts in young and quasi-democracies.

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

From a theoretical standpoint, the moral hazard (a situation where the costs that could incur from a decision will not be felt by the party taking the risk) 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.

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. 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. 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. It has been shown that rent-seeking by bureaucracy can push up the cost of production of public goods.

American economist and social scientist 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 WWII. 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.

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