Rent-seeking

A Tdj by Larry Willmore.

I am a great fan of John Kay, so I am sad to report that his column in last week's Financial Times is a disaster. Perhaps even a gifted writer is entitled to an off-day.

The column begins with an inaccurate and unhelpful definition of the economic term 'rent-seeking':

“You can become wealthy by creating wealth or by appropriating wealth created by other people. When the appropriation of the wealth of others is illegal it is called theft or fraud. When it is legal, economists call it rent-seeking.”

John Kay, "Powerful interests are trying to control the market", Financial Times (11 November 2009).

http://www.johnkay.com/politics/648

This statement by Kay is totally wrong. Rent-seeking can be legal or illegal. And it involves not appropriation of wealth created by others, but rather the appropriation of value ('rents') that result from government restrictions on economic activity.

The term 'rent-seeking' was coined by Anne Krueger in a classic 1974 paper. In the very first paragraph of her paper, Ms Krueger explains that government restrictions give rise to rents, and people often compete for a share of these rents. "Sometimes, such competition is perfectly legal. In other instances, rent seeking takes other forms, such as bribery, corruption, smuggling, and black markets."

Ms Krueger is a trade economist and was Chief Economist for the World Bank from 1982 to 1986. It is not by accident that she chose import licenses - rather than tariffs - as an example of rent-seeking. Tariffs do not generally give rise to rent-seeking, since the scarcity value ('rent') of import restrictions is captured as taxes on imports. Rent-seeking takes place only when producers lobby for new tariffs or for retention of old ones. The scarcity value of import quotas can also be captured by government if the import licenses are sold by auction to the highest bidder. This is not the case with Ms Krueger's example.

John Kay's concern in this column is with concentration of economic power. This is an important subject, but one that has nothing to do with rent-seeking. Rent-seeking can and does take place in a competitive environment.

Anne Krueger's 1974 paper can be downloaded at http://bbs.cenet.org.cn/uploadimages/2004132356266152.pdf


DOW: The notion of “rent-seeking” is different from but related to the concept of “economic rent”. Economic rent is defined as an excess distribution to any factor in a production process above the amount required to draw the factor into the process or to sustain the current use of the factor. It arises, for example, as David Ricardo first explained, in the form of differential land rents which represent the difference in the productivity of one plot of land compared to the productivity of the poorest land similarly situated and used for the same purpose.

In contrast to opportunity costs involved in using factors of production, economic rent does not determine price but the other way around: Price determines economic rent. Example: All farmers receive the same price for their corn but some farmers have more productive land and a greater crop and hence earn a higher income, some of which is economic rent. If the price of corn fell, the farmers with the better land would continue farming while those with inferior land would have their income fall below the acceptable and stop farming. Because the farmers with the better land continue to farm, even when their income is reduced, part of the earlier and higher income they received was “an excess distribution … above the amount required to … sustain the current use of the factor”, to quote the definition above. That is, any income above the minimum required to keep the farmer farming, is economic rent.

Government restrictions artificially raise prices and in doing so generate the potential for economic rents, which attract rent-seekers. Rent-seeking would not exist without restrictions imposed by government policy.

Although I know of no empirical estimates of the magnitude of rents created by government restrictions, they must be huge. Otherwise, why would all those rent-seekers (better known as lobbyists) be crawling all over Capitol Hill and the White House?

I, too, am a great fan of John Kay. We all have our bad days.

Thanks again to Larry for the Tdj.