Looking for rent-seekers in all the wrong places

Professor Paul Frijters recently wrote about the role of economists in the fight against rent-seeking.

The search for more privilege is normal but, in order to have a healthy society, so must there be a perennial fight against it for otherwise the privileged end up lording over the rest who just have to grin and bear their inferior status. And if any profession is tasked with thinking about how to tackle privilege, it is economists. It is one of the good things we do.

It’s a noble cause, and one that I support.  Having been involved on both sides of the market for political influence – property developers on one side, and government departments and regulatory bodies on the other – I feel I have gained a certain perspective on this issue that doesn’t quite resonate with the mainstream economic view.

From the comments it is quite clear that economists generally support the idea of a ‘fair go’ for all, and to cut back rent-seeking privileges wherever possible.  But unfortunately, as I have mentioned many times, mainstream economics has no accepted model of economic rents in a market economy.  Rents are always a result of market failures, regulatory capture, or some kind of other favourable regulation. If the market was perfect, economic rents would evaporate.

This theoretical baggage is not helpful.  Funnily enough, it leads to a focus on government as a breeding-ground of rent-seeking, since perfect markets eliminate any such activity – at least in their model.

A proper starting point would acknowledge that economic rents are generated at all times by productive activity.  Each time we improve output per unit of a particular input, and that input is fixed, owners of that input gain an economic rent.

Land is the obvious focus for the study of rents.  But consider the same concept in a slightly more abstract setting – time.  Without saying it explicitly, when we talk about economic growth and output we usually mean per unit of time.  Thus, every improvement of output per unit of time goes to those ‘owners’ of time.  Which is everyone.  The perfect tax is a ‘head tax’ which is in fact a time tax per person.

But since rent also accrues to land owners, owners of intellectual property and copyrights, owners of quotas and licences, and all fixed inputs into production, they may very well compete for both improvements in output per unit of their input, AND the surplus generated by increasing output per unit of time.

The distribution of rents through society ultimately depends on the legal, institutional and social arrangements of a country.  It is a choice.

The general rule of thumb is that rents cannot be destroyed, only reallocated. Thus, if we focus on taxi licences, pharmaceuticals, and government spending as areas to eliminate the ability to procure rents, then remaining rentiers will benefit – landowners, banks, and the like. Indeed, if eliminating these rents improves the overall productive capacity of the economy, the rents accrue to other owners of fixe factors of production may be great than those taken from the targeted sector.

If economists want to be society’s heroes, they need a fundamental market model that can be used to analyse the distribution of the economic rents generated by society.

Let’s look at Frijters’ list of cases where rent-seeking could be targeted, and my reaction.

1. banana import bans, 

Well, there is far more to ‘free trade’ than most economists realise.  This is possibly the smallest issue around right now.

2. the take-over of semi-public institutions by overpaid bureaucrats,

This is of course the problem with attempting to create government owned entities that are able to act like private enterprise.  Is it an argument for government departments to directly operate all government activities? Or for privatisation, where overpaid executives will capture rent through their pay and options, which might be ten times higher?

3. over-subsidised medicines, 

I have no idea what this means.  Subsidies for medicine simple fall under the banner of public health, which we all seem to agree is a priority.  Some medicines may be over-subsidised, some under-subsidised, but by what measure I don’t know.

4. differential costs of government deposit guarantees across financial institutions (which was probably instrumental in killing off many of the smaller financial players), 

Well, there is far more to banking than having another player join the mix, only to siphon off revenue to over-pay their senior executives.

5. and the National Broadband Network

I have no idea what is wrong with this.

These are all small fry, especially when compared to land owners and bankers.  In Frijter’s follow up post he explains how privileged rent-seekers are protected by the myth, or folk-story, that surrounds them.  He explains in the case of the medical professions –

…medical specialists have a legally guaranteed monopoly on particular medical activities…

Now, whilst this reality is known by the insiders, this is not the public face of medical specialists at all. In the eye of the public, these are the heroes in Dr House and Gray’s Anatomy.

The economics profession as a whole has in fact fallen for their own folk-story about the nature of rents in regards to land ownership and banking (where private banks generate rents through seignorage).  When the profession debates rents, these largest of rent-seekers are absolutely ignored.

The problem of course is that economics as a discipline does not a have a core working model of rents.  Which means it is hard to put your finger on what is rent seeking.  They get part the way there with models of monopolies, duopolies, imperfect competition. But invariably they all lead to the conclusion that there exist conditions, where markets are perfect or close to it, that economic rents cease to exist.

This is nonsense.

Since economic rents always exist, the question is how they are best distributed to achieve the social goals of society? The history of political-economy and moral-philosophy used to debate these very topics that economists ignore.  And we need to bring back this debate. No longer can economists claim to be ‘technicians’ – with objective approaches to analysing distribution.

We shall wait and see what Frijters’ future posts on this topic reveal about the mainstream view, where it is useful, and where it falls short.

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Comments

  1. Hmmm I think you need to spend a few years living in some countries with low rent seeking behavior.

    Low rent seeking economies are dynamic, people try something, if it does not workout well they try something else. Shop’s open and close, service businesses find ways to differentiated by pandering to some aspect of consumer demand. This dynamism is contagious, at dinner parties everyone talks about the gold-mine of a business that some friend has just built (rather different from the Aussie year 2000 discussions of how smart an investor they are because they max’ed out their credit to buy a house).

    The realization that you can succeed shapes all of your decisions, for a start capital allocation becomes an active focus for the individual. You ask yourself the question, What would I do if I had an extra $XXX?

    Some people hate this dynamism because it means instability, shops come and go service businesses that existed disappear, probably because they were never really profitable.

    Fortunately I love change, so I always drift towards the unregulated sections of the economy.

    • Brilliant.

      I’ve seen that with some peers who’ve left the cubicle grind. They have enough to live cheaply from their dividends in Asia, and try to develop product fro some Thai or Filipino beach.

      One customer, begets two, begets 3, etc.

      The cost of failure is so low, and the internet has made barriers to very low, that waking up the following day from failure with a new idea and pursuing that builds momentum into their entrepreneurial skillset.

      With a critical mass of peers, they feed into each other and spur their creativity.

      The equivalent here would be as easily enough to live in a shipping container in Moe and putting it on dirt cheap land.

      As long as Moe has the NBN, then this can be recreated in regional Australia.

      But plenty of rents need to be extracted from land in Moe (of all places) ehh?

  2. ” Rents are always a result of market failures, regulatory capture, or some kind of other favourable regulation. If the market was perfect, economic rents would evaporate.”

    Not sure that the language of rents helps a great deal.

    Trying to work what part of the return on an activity is rent and what part is fair or reasonable or efficient seems like an impossible task.

    Economists may be better of directing their attention to understanding the costs of various activities and decisions and regulations or the lack thereof so that we can make informed decisions as to what we want as a community.

    In most cases the average person has no idea of the costs they are paying as the result of regulation in many many areas that may produce a benefit but at great cost.

    Likewise they have no idea of the reduced cost resulting from some regulations.

    What is disturbing is that while the ‘cost of red tape’ is often mentioned the discussion rarely gets beyond rhetoric.

    One of the most striking examples dear to the hearts of many at MB is how a hectare of farm land can magically increase in value many many fold simply by the application of a few regulations and requirements.

    Breaking down the various contributions to that increase might provide people and voters some insight as to the costs of the choices we make or made by those who do not bear them or can afford to bear them and thus see no problem in requiring what they would consider to be ‘higher standards’.

    By and large – regulations should be viewed with considerable suspicion and be subject to regular and critical review to ensure the benefits they bestow are clearly worth the cost.

    • Agreed, the language doesn’t help at all really because “rent” is such a poorly defined term for the masses.

      The challenge is, as Rumplestatkin points out, is that this whole argument is subjective and philosophical in nature at the same time as being the providence of a field of study which proclaims itself to be heavily scientific and objective in nature…not a good mix to begin with.

      Either we are ignoring the obvious and “don’t mention the war”, or our ruling class have actually been drinking the cool-aid and now believe that this constant rent-seeking is, in some twisted fashion, actually benefiting society. If it’s come to that then this is a moot point and it’s all too late anyway.

      I’m also a little challenged on this because I personally don’t know where the line between collective benefit and unearned rent exists. At what point does a well intentioned regulatory framework such as a registration scheme become a government sanctioned and enforced comfortable oligopoly? Take the medical profession for instance. It’s not that we as a society want under qualified doctors operating on people due to the potential for adverse health outcomes, however with many specialists now commanding incomes in the seven figure range, and with waiting times of many months (whilst some patients get worse and potentially don’t reach their appointments), how is this assisting the health outcomes of the community in general. Does anybody even deserve to earn this much simply because the government has created near impassable barriers to entry? It’s not hard work, nor luck which created this situation, it’s a restrictive system which diverts rent from other productive sectors of the economy to the privileged few.

      Almost any area of the economy where the government gets involved creates a distortion of rent. Immigration, environment, housing, banking, medical, education, military…the list goes on.

      That’s not to say I advocate a complete hands off/small government regime, it’s just that I wish we had some way of calling our politicians to account when they misrepresent policy positions behind a thin veil of community benefit, all the while filling the trough for those who have sought such changes.

      I completely agree that we need more independent rigour and transparency around cost/benefit both before and after any legislation is implemented relative to the social objective the policy position is introduced in support of.

      Pipe dream I realise but nice to ponder briefly.

      • With reference to the medical colleges there is a simple solution to the problem of the barriers to entry being more about market control than professional standards.

        Require specialists to re- sit every 5 years the exams that every new applicant to a speciality must sit.

        This will ensure that the content of the exam is important and not merely a pretext or method for keeping numbers at a level that ensures pricing power is maintained.

        If an experienced and competent specialist cannot pass the exam thar would suggest the exam is more about keeping candidates out.

    • Of course, that hectare of farmland magically increases in value arguably more by the removal of regulations – the removal of the restriction that it can only be used for agriculture – than by the application of regulations.

      • It is that very regulation – limiting the way land can be used – that generates scarcity which generates value that can be secured if one is able to acheive a change in the regulation ( rezoning).

        Without the regulation the scarcity would not arise.

        • I can’t agree here Pfh007. Scarcity arises even if all privately owned land has no restrictions on development, simply by virtue of being physically limited in area.

          Zoning essentially says what can be built where to avoid conflicting uses.

          I’m not sure how we can believe that

          1) removing zoning on half the land increases the value of that land (while the zoned land prices remain unchanged)

          while at the same time believing

          2) subsequently removing zoning on the other half decreases the value of all land to zero.

          There is simply no consistent way to believe this. And If you think I’ve been extreme by saying that all land goes to a zero price, you will need to have an explanation of where the price comes from.

          • Cameron, read “Office space supply restrictions in Britain:
            the political economy of market revenge” by Paul Cheshire and Christian Hilber.

            http://eprints.lse.ac.uk/4372/

            Office rents are considerably more expensive in almost every city in the UK, than they are in almost every city in Europe, which in turn are considerably more expensive than almost every city in the USA.

            If you can’t see the role that zoning and regulatory distortions MUST play in this…….well, are you an economist at all?

  3. It s good that Unis are shutting down their dept school of “economic” one after another, what a useless bunch of bullshitters and rent-seekers.They really do not warrant degrees.

  4. Diogenes the CynicMEMBER

    Yes there are plenty of rent seekers in University Economics corridors, scurrying around to preserve their tenure.

    How about a using transparency as an antidote to rent seeking? Not the silly faux transparency system we have in place now but full bore 21st century Facebook books open transparency. ie why can banks use internal models to measure their risk on their portfolios – make it open and public. Why can the government not release its MRRT modelling or revenue data? Make it public. Where transparency is blocked or under a snowjob rent seeking and often corruption is usually buried somewhere underneath thriving like a mushroom.

    • Yes there are plenty of rent seekers in University Economics corridors, scurrying around to preserve their tenure.

      As I stated above. The cost of failure in Australia is extremely high.

  5. The economic thinking in recent year tends to justify rent seeking, rather than eliminate it. I mean, it’s got to the point where most academic paper can be summed up as “Business Good, Government Bad”, and then manipulate the data to fit their model.

    Take for example the idea that the Telstra monopoly is challenged by the mobile phone operator : broadband internet and mobile are completely different markets!! Further more, the ‘competition’ only exist because the government spectrum allocation creates an oligopoly. If it’s “free for all”, then Telstra can buy on all the spectrum and charge whatever they like!!

  6. “…..The general rule of thumb is that rents cannot be destroyed, only reallocated…..”

    Cameron, if you have never read Robert Murray Haig’s theories on transportation and urban land rents in “Toward an Understanding of the Metropolis” (1926), I know you will find this absolutely fascinating.

    It is well worth getting:

    “Transportation, Urban Land Values, and Rents: A Synthesis”
    By Michael A. Goldberg (1970) for an overview and development of Haig, Alonso and Wingo.

    Basically, there is a correlation between the flexibility of the transport system – i.e. how much supply of land it brings into the urban economy – and the LEVEL of economic land rent. The more flexible and low cost the transport system and the more land brought into “supply” in the urban economy, the higher the TOTAL sum of economic land rent (over and above basic non-urban levels) but the THINNER this rent is SPREAD.

    Basically, this is what automobile based development without growth-containment urban planning does to an urban economy. The pre-automobile urban economy was marked by VERY HIGH economic land rent per existing site – this was commonly understood, it was not just Marx and George who were famous for this insight. Rail-based sprawl did not make a lot of difference because the total amount of land brought into “supply” was in long ribbons and was always captured by rent-seeking interests.

    Genuinely competitive automobile based development is what made all the difference – the uplift in value over rural values when land was developed, was minimised for the first time in the history of urban growth. This affected the economic land rent curve for the entire city. This is why land values are just as low “everywhere” in Houston, compared to “everywhere” in LA or London or Sydney – because the former’s values are anchored in true rural values – the urban land rent curve slopes up gradually from the urban fringe. The peaks are commensurately lower. Growth-constrained cities have what the LSE’s land economists call a “discontinuity” at the fringe; the peaks in the “curve” are deflected upwards along with the entire curve.

    But Haig, and even Goldberg in 1970, did not account for regulatory distortions.

    This is a major exception to the rule that rents cannot be destroyed. MASSIVE amounts of economic land rent WOULD be destroyed in a growth-contained city which abolished its constraints. The economic land rent associated with growth-containment planning is the single worst example in the world today, of rent-seeking that is “not being looked for” by the economics profession and advocates and politicians.

    Cheshire and Mills say in their introduction to “The Handbook of Regional and Urban Economics” Volume 3 (1999):

    “…….If we compare communities in the US and UK that are as comparable as possible except for the constraints their systems of land use regulation place on the supply of land, we observe that the price of retail land is up to 100,000 times higher in the most constrained community…..”

    No economic rent seeking to see here, move along please, move along…….

    • Great comments Phil.

      By the way, Bryan Kavanagh does a nice job in quantifying the amount of privatized rent in Australia at 27% of GDP in 2005.

      See figure 1 – ‘Classical Components of GDP: 1911 – 2005’, pg 6. in “Unlocking the Riches of Oz: A Case Study of the Social and Economic Costs of Real Estate Bubbles 1972 – 2006”

      It is clear those filthy land squatters and mineral hoarders are getting WAY too sweet a deal, but for some reason the answer is always to tax labour harder or to raise the GST. Funny that…