Why is rent seeking so bad for competition, growth and freedom?

PUBLISHED : Tuesday, 14 June, 2016, 3:14pm
UPDATED : Tuesday, 14 June, 2016, 3:14pm

Rent seeking is one of the core pillars of the study of political economy. Its use in economics is negative and denotes detrimental political and economic activity. Why is that so?

Under most circumstances, the owners of an input of production -- land, labour, machines, and capital -- will only be able to earn a normal profit (as opposed to a high profit) because competition in the market place will equalise their returns.

The only way for owners of an input of production to extract additional profit would be to cartelise and monopolise. The most effective way to do this is to lobby government to set up regulatory and legal barriers to market entry.

The process of lobbying government is a political process. Economists call such lobbying “rent seeking” because the objective is to secure economic rents that are higher than the normal profits obtainable by competing in the economic market place.

China’s high economic growth rates in the past three and a half decades have been the result of curtailing rent seeking

In the economic market, competition drives down costs and promotes innovation, because both incumbents in the market and newcomers can constantly challenge successful firms and individuals.

In the political “market,” the purpose of competition is often to secure government authority to limit market entry by newcomers so as to earn higher returns through cartelization.

The political competition that underpins this rent seeking creates not only a less competitive economy, but a more divided society and a less inclusive polity that curtails freedom.

Industries that are heavily regulated by government, where business has to constantly work closely with government, are much more prone to rent seeking. Building, construction, development, transportation, mining, energy, communications, and so on are often characterised by a high degree of government regulation.

Rent seeking is also more pervasive in less market-oriented economies because the government allocates a large share of the resources (or inputs of production) in society. Societies with big governments and planned economies have more rent-seeking activities and are less efficient and innovative.

China’s high economic growth rates in the past three and a half decades have been the result of curtailing rent seeking through reforms that limit the reach of government and expanding market competition, in contrast with the previous period.

A profoundly devastating issue in rent seeking is the dissipation of economic rent into the rest of the economy. This happens when individuals and businesses commit resources to lobbying government officials and politicians in order to secure higher rent seeking profits.

Such resources can take many forms – hiring lobbyists, launching an advertising campaign to influence public opinion, funding writers and opinion makers to drum up public support, organizing protestors or advocates, and so on – day to day politicking.

These resources cut into the higher economic rents to be gained if the lobbying is successful. There may also be competitors spending on their own rent seeking, as well as parties who lobby to prevent the creation of any such economic rents.

Spending on rent seeking efforts transfers income rather than creates income. The hired lobbyists, advertisers, writers, etcetera could have spent their time and effort in other more productive activities.

Professors Kevin Murphy, Andrei Shleifer, and Robert Vishny showed that the most devastating aspect of rent seeking behavior is that it creates incentives for individuals to choose careers specialising in rent seeking work.

Using enrolment in law studies as a proxy for rent seeking work, and enrolment in engineering studies as a proxy for entrepreneurial work, and applying that to a sample of 55 countries during 1970-85, they found higher enrolments of law students were associated with lower growth rates, while higher enrolments of engineering students were associated with higher growth rates.

One argument in favour of democracies is that in an open society, everyone can lobby government – the idea being that political competition could achieve a dynamic shifting balance of interests to limit excessive rent seeking. But in practise, few countries attain this balance.

If 100 businesses conspire to raise the price of a product by US$1 and one million customers each buy one unit of the product, then each business will earn US$10,000 but each customer will lose only US$1. The incentive for the 100 businesses to become organised and lobby government will be much larger than the incentive of one million customers to organize and mount a counter-lobby.

Furthermore the cost of organising 100 businesses is much smaller than organising one million customers.

Rent seeking harms economic growth by reducing competition and innovation. It leads to the wasteful use of valuable resources and talents in unproductive activities and invariably redistributes resources from large unorganised populations to small organised groups.

Rent seeking is not only bad for economic growth because most rents are ultimately dissipated, but it also produces divided societies and non-inclusive polities.

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