ECON 369
Lecture Four – Public Choice: Rent Seeking
Sources: Gordon Tullock, "The Welfare Costs of Tariffs, Monopolies, and Theft," Robert Tollison, "Is the Theory of Rent-Seeking Here to Stay," Crony Capitalism in America 2008-2012 by Hunter Lewis and other sources (see text).
Rent Seeking (Tullock’s definition – since he pretty much invented the concept): “The use of resources for the purpose of obtaining rents for people where the rents themselves come from some activity that has negative social value.”
Rent: earning above your opportunity cost (when talking about rent seeking with respect to a business):
Graph:
Example: the U.S. automobile industry spends money to get tariffs passed (the activity). The tariffs themselves make U.S. citizens worse off even though the auto companies will gain (negative social value).
Another example of rent seeking: Direct income transfers by the government in which A is taxed and B receives the money. Old people are "rent seeking" when they want social security payments to remain in place long after they have received what they put into the system.
Lewis has a long list of ways by which "private" firms and organizations reach out and try to ally themselves with public officials. Much of this list are ways by which rent seeking occurs - including regulation that discourages new or small companies, loan guarantees, subsidies, bail-outs, favorable price restrictions, and the list goes on and on.
We must distinguish between “rent seeking” as in coming up with a cure for cancer in order to get rich. This is “rent seeking” but does not have the same consequences. Why is this different?
Profit seeking versus Rent seeking
We think of the competitive process as weeding out the inefficient producers – which is “socially desirable.” When firms seek profits by competing resources are moved to higher valued uses (typically). Or at least knowledge is gained about resource value in the process. Output or productivity is increased through this process.
Rent seeking arises where output is given and fixed, as in the case of monopoly rents:
To protect itself from competition, a firm can engage in innovative research and development. Any product or production improvements that are successful are likely to be copied by competitors – resulting in the first firm bearing the up-front costs while other firms are able to share the resulting benefits.
Patents can be issued to protect the first firm’s investment, giving that firm a monopoly on its innovation (at least for some time). Thus firms may use resources in the innovation process to secure the resulting monopoly rents. Since innovation and technological improvements are generally considered socially enhancing, this represents a socially beneficial use of resources.
On the other hand – monopolies can be created for reasons other than innovation protection – examples:
“natural monopolies” – Which, don't really exist anyway when we consider time and innovation.
Graph:
Governments restrict access to these markets – so which firm gets the government granted monopoly?
Each firm now has an incentive to lobby government officials for the right to be the monopolist.
Lobbying, in this case, is socially inefficient since the (potential) firms are now using scarce resources not to create new production that would not otherwise exist but simply in an attempt to redistribute monopoly gains.
The resources used to gain the monopoly right are socially wasteful. Thus there is socially harmful competition to become the monopoly.
Socially Harmful Rent Seeking Need not be Limited to Government Policy
Example: the Super Bowl. In order to be fair – the game is played in a “neutral” place – determined ahead of time. While this might appear to be “fair” the question remains as to where to hold the game. Since the Super Bowl attracts a lot of visitors – the selected city will benefit greatly from increased business, tax revenues, etc.
Potential cities spend a great deal of time, energy, and money to lobby the NFL commissioner’s office to select their city as the monopoly host site. From a social standpoint, this resource use is wasteful. Even in the absence of lobbying (for example, if the NFL simply drew a lottery from all NFL cities) the Super Bowl would exist – the only question is which city in particular would reap the rewards.
If for some reason the NFL was planning to eliminate the Super Bowl, and the lobbying took place to create (hold) a Super Bowl, this resource usage could be socially beneficial (to the extent that people enjoy watching the Super Bowl), but resource use simply to decide who gets the monopoly rents is not.
The key is whether society as a whole is better off as a result of the activity or product that generates the rent.
As Tullock puts it – perhaps the most useful way to think about rent seeking is in terms of using real resources to capture a pure transfer. Since expenditures to take a dollar from Bob and give it to Betty produce nothing, they are wasted from the point of view of the economy at large; they are zero-sum at best and are probably negative-sum.
Example: a lawyer employed to transfer a dollar from A to B has an opportunity cost in terms of the lawyer output he or she could be produced alternatively. This opportunity cost is the social cost of rent seeking!
Therefore – the greater the possibility of wealth transfer through the political (or other) process – the more rent-seeking will occur.
Origins and Social Costs of Rent Seeking
The concept refers to legal and illegal activities to obtain special privilege such as seeking monopoly status, special zoning, quantitative restrictions on imports, protective tariffs, bribes, and threats.
Standard neoclassical theory - It was thought that there was simply a transfer from a monopoly privilege: to the pressure group and from consumers who pay higher prices. The only loss was perhaps the “welfare” loss of consumer and producer surplus due to a reduction in trade.
Review of producer and consumer surplus (gains from trade):
Graph:
GRAPH - Standard Welfare Costs of Monopoly Rent Seeking (to make it easy, let's assume constant Marginal Cost or a horizontal Supply Curve):
The old theory of monopoly: producers capture PmACPc as a transfer from consumers.
ABC (deadweight loss), however, vanished form the economy as a result of the monopoly – less trade, loss of the benefits from the trade.
Tullock looked at this same type of analytical model, but posed the following question: what if PmACPc is not a simple transfer from consumers to producers? Instead, that those producers who aspire to be regulated (restrict entry for example) have to spend real resources to capture the potential transfer of PmACPc?
Tullock discovers rent seeking –
Simple game: Fixed number of bidders for the government monopoly right (say, 20).
Value of the right - $100,000.
Each person bids $5,000 for a one-in-twenty chance of winning the $100,000.
So $100,000 is spent to capture $100,000! In this case, PmACPc is exactly or perfectly dissipated, and the social costs of the monopoly is a trapezoid PmABPc – which consists of the Tullock or rent seeking costs PmACPc, and the deadweight cost of monopoly, ABC.
So the social costs of monopoly and regulation increased substantially with this analysis.
But wait – where did the $100,000 go? They went to government officials, say taking them out to dinner or giving to their political campaigns. This is surely valuable to the government officials – so there’s not a total social cost of $100,000.
But again, a small group benefits at the expense of society generally.
This was just the beginning of the analysis of rent seeking and its social costs.
So generally speaking, the opportunity cost of those resources used to obtain the regulation is part of the loss - that isn't shown in the graph.
Tullock's General example: Consider a steel mill in the U.S. that faces Japanese competition. The firm has two choices:
1) It can invest resources in new technology, state of the art plants, etc. and meet the competition head on.
2) Or it can invest resources lobbying to restrict the imports.
If the cost of getting the restriction is lower, steel manufacturers will never build new plants and steel production will remain inefficient – we are out the lost opportunity cost of the resources that would have been released with new efficiency (minus the value that the beneficiaries of rent seeking obtain – lunches for politicians, etc.).
Since we do still see companies investing in new technology, etc., lobbying must be pretty expensive.
But -- Problems with the Analysis?
According to Pasour (and others):
The standard neoclassical view of monopoly is wrong. A monopoly through creativity (first on the market) does not create a loss to society. But a gain. Why -- because the so-called monopoly price, etc. should not be compared to "perfect competition" (lower price, more output, etc.) but instead to no production at all!!
Graph:
In other words, unless government is involved -- there is no such thing as a monopoly price or a competitive price -- only a market price.
However, with a government granted (or created) monopoly -- there is still a comparison. Of course we cannot know what the price and output would have been in the absence of the government barrier -- however, with the barrier there is a movement of resources we can talk about.
Uncertainty in both the market process and in the political process. So we can't assume that the resources spent on rent-seeking = the prize!
But what about efficiency? According to Pasour - how can we judge rent seeking? What does it depend upon?
It is assumed that a system that moves resources to where consumers want them is good. Taking resources from consumers (and taxpayers) and giving them to politicians and special interest groups is bad? But why?
Tullock's assumption is that concentrated benefits and dispersed costs are a bad thing? Why?
What else - any other criticisms?
Rent Protection
The cost of rent-seeking doesn’t stop with the above analysis of monopoly or regulation. Not only do individuals use real resources to seek transfers, but they also sometimes use real resources to protect their rents from other rent-seekers!
This behavior is known as “rent avoidance” or Tollison calls it “rent protection” – so that’s what we will call it.
Sometimes it is worth spending $1 to save $2.
Simple example – an excise tax analysis.
Excise tax:
GRAPH - Costs of an Excise Tax
Traditional analysis (three results):
1. ABC is the deadweight loss from the tax – again less trade.
2. EACF is the tax revenue that is transferred to government
3. The incidence (who pays) of the tax is split between consumers (C) and producers (P) as a function of the elasticities of demand and supply.
What if demand were perfectly inelastic (theoretically), for example:
All of the tax paid by consumers.
But let’s go back to the standard analysis but now include rent protection:
Assume that consumers are unorganized and have no rational incentives to organize to resist the loss of consumer surplus that the tax imposes on them. However, producers are organized and prepared to lobby against the tax. In this case, producers may spend up to their loss of producer surplus, PcBCF, to resist the tax or to keep it from being higher than it is. This is the amount of wealth that the tax takes away; from the industry. These expenditures are a rent seeking (protection) cost in Tullock’s terms, and so must be added to the traditional cost of the excise tax (ABC).
Total cost of the excise tax thus equals: PcBCF plus ABC.
So might we conclude the following as economists:
1. Excise taxes in the face of organized industry opposition are not a good idea. (Of course this really undercuts the tax programs of most countries with respect to such commodities as beer and cigs)
2. Virtually all welfare analysis of monopoly and regulation ignore rent-protection activities of organized opponents of such governmental programs.
3. A more complete analysis will include traditional deadweight loss or costs, rent seeking costs AND rent-protection costs!
Tullock’s Categories of Rent-Seeking Costs
The costs of rent seeking fall into several categories: (from Tullock)
Direct Costs of Rent Seeking:
1) The cost of the lobbying establishment. Look at Washington, D.C. – expensive restaurants where you can take members of Congress or to dinner. Other entertainment less widely publicized. The U.S. government subsidizes the rent-seeking industry by maintaining such publicly funded places as the Kennedy Center. It is a relatively inexpensive place to entertain congress. Actually this cost is probably a relatively small part of the total cost of rent seeking.
2) Campaign contributions. This also would be considered a small cost of the total cost of rent seeking.
3) Costs of establishing special privileges (or protecting oneself – as above). Lobbying is a gamble. Many try to get the special privilege and spend resources, but only one firm gets a pay-off. All of the spending is wasted.
4) The real cost to rent seeking comes from the distortion of the voting process. This relates to logrolling (which we will discuss later in our voting section):
Logrolling:
One special interest group rent seeks for a project. Taxpayers who will benefit from the project, thinking their share of the cost will be small, vote for the representative who votes for it. But with vote trading – in order for the one project to get passed, how many others were passed too? So the taxpayer’s cost of that one bill could be huge!!
The inefficiencies in government that come about through special interest rent seeking are huge! Can’t be measured – don’t know all of the trades.
All of these can be considered direct costs of rent seeking. But there are also indirect costs – which can be considered even worse.
Indirect Costs of Rent Seeking:
1) Pulling intelligent and productive people into an activity that has no social product, or may have a negative social product, is more important. (Tullock)
2) Deb’s idea? Could rent-seeking be contributing to the anti-market bias (that Caplan talked about)? People hate markets/corporations? Why? Marxist explanation, anti-market bias, etc. – but I think there is another more modern one: Rent-seeking. Instead of understanding that it is the political process that allows the rent-seeking, they turn their anger to those who do it (and don't recognize that non-corporate entities also rent seek, like environmentalists, labor unions, old people, etc. -- or think it is OK for them to rent seek but not for corporations to do so). If what comes out in the end is non-productive, it doesn’t matter who did the rent seeking – it was still wasteful.
Why a cost – well, if Caplan is right, then the myth continues – which leads to bad policy, which then creates more costs.
Possible answers to rent seeking costs: Generally speaking constitutional reform is necessary.
Direct Popular Vote:
(who would you rent seek?)
Do not allow the special privilege:
(but how)? Do not provide government granted monopolies or tariffs, etc. – then there’s no reason to rent seek.
Forbid former government employees to lobby the agencies where they previously worked;
Require disclosure of all political campaign donations along with the source of independent campaign expenditures;
Require disclosure of all loans and terms or other financial assistance to public officials;
Forbid government-industry partnerships:
Repeal and radically simplify the present tax system:
Forbid regulatory agencies from assuming an executive, legislative, and judicial role, thereby making a mockery of constitutional separation of powers:
Abolish all government-sponsored enterprises (like Freddie and Fannie):
Turn over the development and implementation of public assistance programs to charities to ensure that they cannot be used as vote buying schemes, etc.:
AND GENERALLY SPEAKING: Systemic reform that takes government out of the business of influencing, manipulating, or controlling market prices. Why?
But these are, of course, much easier said than done! There are no clear answers here.
Rent Seeking and the Distribution of Income
Pre-Tullock – the effect of monopoly on the distribution of income was clear: the monopolist got richer and consumers got poorer.
Rent-seeking has a pronounced impact on the distribution of income – the winner of the monopoly right becomes wealthier.
We can’t conclude outright that this would not level the distribution of income – maybe the winner was very poor and this increase in income brought him up to meet his fellow citizens.
It does seem a little far-fetched, however, to think that rent seeking generally promotes any leveling in the income distribution of an economy. Set in a world of tradition, class, privilege, political power, and differential organization costs, rent seeking most likely promotes more inequality in the distribution of income.
More realistically – there will not be an equal distribution of rent seeking ability in a society.
Conclusion: What Hath Tullock Wrought?
This is a quotation from Robert Tollison: “ . . . the most interesting thing about Tullock’s ingenious insight is how simply he put it. Like Coase, he communicated his vision in terms that every law economist could follow. This is a criterion by which greatness in science is measured. In economics, the Tullocks of our profession are more indispensable than ever. To wit, the scarcest thing in any science is a good idea, clearly communicated.”