To seek rent or not?

Rent-seeking has been a popular topic on this blog over the past week. In the comments of this post, Mike M asked if a company seeking to sell its products to government is rent-seeking.

I replied, yes and asked him what he thought.

Here are excerpts from Mike M’s well-thought out follow-up:

 I think there is a difference between “selling” your product (goods or services) to the government (just like an other consumer) and convincing them to buy your product (as opposed to others) and seeking to have the government (as a third party biased referee rather than as a consumer of your product) afford you some privilege that gives you an advantage (such as subsidizing your product or taxing or regulating the competitor’s product).

 In the first case, as long as the government representative is truly acting for the benefit of the government, he should be seeking to make a trade at FMV.

I agree.

A “rent” is essentially an excess return above the “normal” return in a competitive economic market.

Typically, we use the term to imply that one has lobbied the government to obtain some special privilege – something that’s been going on since governments and economies have existed and is not a unique occurrence in any economic system (although that does not mean that it is meant to be a part of that system). Rent-seeking differs from profit-seeking, in which two parties seek to extract value by engaging in mutually beneficial transactions.

What is important for us to realize is that the costs spent on lobbying for these privilege eliminates some of the beneficiary’s gains for the privileges and results in an economic inefficiency, i.e. less output results from the same inputs. The cost of obtaining the rent represents a use of real resources and is a loss to the economy as a whole.

I agree. Also, I think it’s worth highlighting that the cost of obtaining the rent is the rent-seeking.

The next excerpt, however, starts to get at one reason — after going through a similar thought process as Mike — I erred on the side of yes.

Of course, this goes out the window if he’s your cousin or you’ve offered him a bribe and he buys your product at an inflated price, but I think that’s a different “crime” than rent-seeking.

Unfortunately, so much of government spending, even if it initially starts out on the up-and-up, devolves into rent-seeking. That’s how we end up with $800 government hammers and toilet seats. That’s how education spending per student triples in a few decades with nothing but shiny buildings (and wealthy builders) to show for it.

While the bribe is a different crime than rent-seeking, it is also rent-seeking, because it is spending resources to gain something without creating value.

Next, government spending comes from taxes. Taxes are not value creating transactions. Rather, they are redistributive. So, government vendors are ultimately lobbying government officials for a slice of their redistributive taxing power.

How is that different from lobbying government for its other powers like enacting a tariff on sugar or restricting competition in a market?

One objection I can imagine to my case is that some of the money spent by government does create wealth.

This is true. But, to say these things create value isn’t enough. They have to create net value relative to opportunity costs.

Roads are great, for example. I’m eagerly awaiting a new road being built near my home. It will be profitable for me, because it will shave many minutes on my commutes.

When I think of that new road creating value for me, I think only of the benefit — how much time I will save. But, I never know the cost.  If the local, state and Federal government (all are pitching in) said I could have that road or $100,000, I might decide to take the $100,000 and continue to put up with the extra minutes on my commute.

So, even when I see government spending that appears to have created some wealth for society, I don’t really know if it did relative to the alternative that could have been if someone had spent the resources more carefully.

What do you think, Mike?  What am I missing?

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18 thoughts on “To seek rent or not?

  1. I guess I’m wondering if any government spending of tax dollars is not rent-seeking?

    That sounds like I’m wording the question to be tricky or trolly – but I swear I’m not. Under this definition of “profit”, “mutual benefit” and “rent seeking” can government do anything BUT rent seeking? What government function that spends money could be portrayed as mutually beneficial to both parties (the government and the people)?

    • I think that’s a good question, Wally. And I think that’s the point I tried to make. Since gov’t spending derives from taxes, and taxes are not voluntary, we don’t know if it’s mutually beneficial. Or, maybe a better way to say it is it doesn’t have to be mutually beneficial.

      Certainly cases can be (and are) made that some of that spending is mutually beneficial, like defense and justice systems, as Mike M mentioned in his previous comment. But the fact that it doesn’t have to be is a problem.

      • Maybe if we start from a simple transaction between two people we can figure out how to determine if a larger transaction between many people (like a government and a population) is mutually beneficial.

        How do we know when a business transaction between two people is mutually beneficial?

        • If it’s voluntary, there’s a good chance it’s mutually beneficial, otherwise why would the transaction occur?

          In hindsight, of course, not every voluntary trade turns out to be mutually beneficial so their is risk involved. But, it’s somewhat self-correcting because we learn from our mistakes. That’s an important feedback in voluntary transactions that doesn’t occur as strongly in involuntary transactions.

  2. Hi Seth and Wally:

    Here’s how I look at government taxation and spending.

    Government is created by the people in a society (and not the other way around) to facilitate law in order in that society so that the people can create the wealth. Government – and all its agencies and functions – are a necessary (or at least an agreed upon) expense of the collective people’s business. When societies set up governments, it was not for the purpose of redistributing wealth or doing good deeds – that was in the domain of individuals, churches and charitable organizations. In other words, charity was an individual choice and not a collective mandate. We can look upon the original purpose of government as a cost of doing business with the understanding that a part of this cost was enabling people to live in close proximity to one another without fear for their property and possessions.

    The original functions of a limited government – and those noted by Smith – were (1) protection of individuals and their property from foreign and domestic threats, thus enabling people to produce wealth knowing that someone wouldn’t simply take that wealth from them, (2) the enforcement of contracts – if I promise to pay you $2000 for a yearly gym membership, the courts will come after you if you close shop tomorrow, and (3) the provision of certain public goods, e.g. public roads and utilities, that individuals can not afford alone. This was not meant to make the government a sugar daddy and provide things that some individuals could not afford, but to prevent the free rider problem.

    Now, if we look at government in its original limited role as facilitating our ability as private citizens to build wealth by protecting our ability to produce and store that wealth, we can not only see that, in this role, government can create wealth – or at least enable us to create more wealth than we could otherwise – but we will readily accept the costs (taxes) imposed.

    When government takes my wealth and gives it to someones else, that’s not creating jobs or wealth for the economy and it’s certainly not “mutually beneficial”. Indeed, if we look at the original basic functions of government and their purpose – to enable me to feel secure in my property and person – it’s obvious that wealth redistribution is contrary to those purposes. The government that was supposed to keep my property safe from others is taking it (really at gunpoint if you consider what would happen if I refused to pay my taxes) from me and giving it to those others.

    As an aside, when we say that an exchange is mutually beneficial, we mean that each of the parties SUBJECTIVELY values what they are getting more than what they are giving up. One chap in a previous post an another thread had difficulty understanding that if junk food is bad for you, how could purchasing a Big Mac and fries be mutually beneficial. The key lies in understanding that the value placed by each party on what the are getting and giving up is their own subjective valuation and not some valuation made by others. Furthermore, even if I know that the Big Mac is bad for me (or rather for my health), I may subjectively value it highly in terms of meeting some other want (like my craving for junk food) and the bad effects it may cause, being remote in time, are given less weight.

    • Let me see if I understand.

      For a transaction to be considered mutually beneficial, all involved parties, at the moment of exchange must subjectively value what they are getting more than what they are giving up.

      Yes?

      • That’s right, Wally. A common mistake made by busy-bodies is that someone else’s subjective value of a product or service should not be different than their own. Mike referenced a good example of it.

      • Minimum wage is another good example. Third-parties impose their subjective value on the price of labor by setting a minimum wage. They believe they know what’s right for the worker who is perfectly willing to work for less than minimum wage.

        • Okay. I think I understand now.

          So when we’re talking about bare minimum government intervention – we’re looking at:

          protection from threats (internal and external)
          enforcement of contracts (legal system?)
          infrastructure (certain public goods)

          So when the public gives the government tax money and the government turns around and delivers these goods, I assume that both parties must subjectively believe that they are getting more out of the exchange than they are getting out of it at the moment of exchange, right?

          My question then becomes, what percentage of the public needs to hold this belief? It seems unlikely that 100% of the people are ever going to agree on what constitutes a mutually beneficial exchange.

        • Except taxes aren’t voluntary, so there doesn’t have to be a mutually beneficial exchange. That’s the fundamental feedback weaknesses of government.

          You could argue that implicitly taxes are voluntary because we elect Congress and we keep electing tax-n-spenders. But, that feedback loop is much less direct that the feedback loop on voluntary transactions — which is the problem.

          If you are interested, I think Thomas Sowell did an excellent job in explaining the differences, which I quoted in these posts:
          http://ourdinnertable.wordpress.com/2010/07/13/five-excellent-paragraphs-from-thomas-sowell/
          http://ourdinnertable.wordpress.com/2010/03/16/how-to-get-people-to-respond-to-other-peoples-desires/

    • SORRY IF THIS DOESN’T LAND IN THE RIGHT SPOT

      Hi Wally – the issue of government providing – perhaps a better term is coordinating (because it’s the taxpayers who are ultimately providing the resources) – certain public goods is the one most subject to abuse. I think that we, as a nation, need to be careful to limit this. It’s real purpose is to prevent the free rider problem. I’ll explain in case your rusty on your econ.

      If the people of Anytown USA and Smalltown USA want to build a road connecting their towns there is an incentive for people to let “everyone else” pay to build the road because once the road is in place everyone – even the non-contributors – will be able to use it (assuming the cost to prevent non-contributors from using the road is prohibitive), i.e. the public good is “non excludable”. These folks who hope to let the other pay for a good that they will later use are called “free riders.” Assuming private citizens are considering building the road and the cost of limiting access is prohibitive or prohibited, due to the free rider problem, the road may go unbuilt even though demand for it is great. Government, through its power to tax (or regulate access to the public space by tolls, etc.) can solve the free rider problem by forcing everyone to pay for the road thus eliminating the free rider problem.

      I agree that this is an area where it is very easy for a government of humans to overstep its bounds. As you imply, we can’t just assume that because a majority votes to have the government levy a tax to pay for some good or service, that it’s a legitimate role of government. If that was the case, it would be legitimate for a majority to vote for a tax that provides “free” donuts to everyone, something I think almost all would view as wrong. Now, if we go back to the Constitution and take it with its original intent, I think you will see that it contains provisions for government taxation and spending for such things. Also, remember that most of the public goods that governments can provide can and should be done at the state or local level and that these units have constitutions as well that permit or prohibit these functions.

      I think our system of income taxation – where almost 50% of our citizens have no skin in the game – contributes to this problem. As Seth knows, I have proposed in the past, some form of per capita tax to replace the income tax. While this seems harsh at first glance, especially for the poor, consider that prior to 1913, there was no income tax. The real problem is not lack of taxes, it’s lack of control on spending. I suspect that if we had a per capita tax with everyone having some skin in the game, people would pay much more attention to what the government was spending money on and much less likely to tacitly approve the massive entitlement programs we currently have.

      To put our current tax and entitlement incentives in training terms, if each time you worked out, the workout fairy took away some of your strength, and each day you sat on the couch doing nothing, the workout fairy rewarded you with extra strength, why would you workout? Substitute work, government and money in the appropriate spots and you see where government has destroyed people’s incentive to produce.

      • Thanks for the reply, Mike.

        Why should local and state governments play a larger role? Won’t they be less able to execute the larger projects that build infrastructure like highways, airports, bridges and the like.

        • Wally – If you look at these infrastructure projects now, what I think you’ll find is that it IS local (state, county & city) governments that are indeed executing the majority of these projects. However, it is the federal government that has taken control of the purse strings. In essence, what happens is that the federal government taxes us far in excess of what is needed for what is (or at least what I think is) their constitutionally defined role. Then, local governments must apply for grants, etc. to get back what was essentially their own citizens money in order to build many of these projects (or to supplement the money they collect themselves in the form of taxes). But the federal government puts many stipulations on these payments back to us local folks, like engaging in or building the projects that it (rather than the locals) want and like hiring quotas on the projects, environmental rules that may make no sense in our particular area, the necessity to involve some other agency or “specialist” that again is irrelevant to our area (but is one of their cronies), etc. It’s like if CFHQ increased your affiliate fee and but said you could apply to get the money back but only if your coaching staff included a certain mix of people and that you hired an ex-con to sweep your floors at night and that you bought Oly bars from Eleiko and that you built a climbing wall (from their approved vendor, of course).

          The locals have a far better idea of what they WANT than the federal government and they are far less likely to waste their money on frivolous projects when they understand that it is their money they are spending versus “Washington’s” money. If you and I both give $1000 to Seth and then have to apply to Seth to get it back to buy something Seth approves of (even though we don’t really want or need the items on Seth’s list), we are going to compete for the money just so we get the “free” money – even though we would have otherwise saved it for something we really wanted later on. If we take this to the local political level, it’s easy to see that local politicians have an incentive (reward their constituents with jobs) to apply for these federal dollars – which were really their citizens dollars to start with – to spend on projects that the federal government wants, but which the locals, if given the choice, would have declined if given the option instead to keep the tax dollars in their own pockets.

          When the tax dollars are kept local, the local governments and their constituents maintain a more direct link in the buyer-seller relationship and are more frugal with their dollars than when they think they are just getting “free” money from Washington. They are more likely to be wary of having their own money ripped off than of having Washington’s money ripped off.

  3. That makes sense, Mike.

    What’s the relative risk under a weak central government model of factionalism, secession and/or the extreme pooling of like minded individuals at the local level?

    I’m thinking along the lines of the free stater movement in New Hampshire – but raised to the level where it starts to cause civil unrest either internally or between the federal government and the state.

    • I agree with Mike, but I think there is another reason why local tends to work better: trial and error.

      We benefit in a world where there are a lot trials, because there are many more errors. Central power is bad for all the traditional bad things folks think about it — it corrupts, the leaders act to benefit their own constituents and the sort.

      But, those aren’t the only reason it’s bad. What’s worse is that it chokes down trials. With many states or many local governments trying to do something it’s like a competitive market. There are lots of natural trials going on and when one happens across something that works, others are free to adopt it, or not.

    • I think what Seth is trying to say is that this may not really be a problem. Indeed, it may be LESS of a concern under a weaker central government. Certainly, under our present system there is an extreme pooling of like minded individuals when one considers presidential elections where certain states have a long history of being taken for granted by one party or the other. As Seth notes, with more control left in the hands of the states, if one state adopts changes that work in terms of what its citizens want (better jobs, better schools, cleaner water, etc.) other states have the option of copying all or parts of what has succeeded there. Currently, we have a bunch of pointy headed gurus and politicians in Washington, at best insisting that we all adopt their unproven theories and at worst pushing laws on us based on some ulterior motive.

      This may be one solution to the many issues that divide us as a nation. If the citizens of some state(s) wish to adopt different laws regarding gay marriage, abortion, welfare benefits, etc. and these issues are not specified in the Constitution as being under the purview of the of the federal government – many feel they are not – the states should individually be able to make their own laws regarding these issues. This will serve not only as a testing ground for such policies, but with our modern day ability to easily migrate between states, also give people more options. All the while, we will also have the collective benefits that were intended when the states joined to form the Union.

      This may actually cause LESS unrest between the states, i.e. “you guys in CA have the right to enact whatever it is you want regarding X issue, but just don’t expect us in KY to bear the responsibility for it.”

      When our country was founded, even though we came together as the united states, there was still a purpose of keeping the individual states instead of doing away with the states as entities.

      • “When our country was founded, even though we came together as the united states, there was still a purpose of keeping the individual states instead of doing away with the states as entities.”

        All I can come up with is high school history but wasn’t the Articles of Confederation our first try at a weak central government and it was abandoned because it was too weak and then the Civil war was our second encounter with the idea and (for better or worse) led to a stronger central government? And then bouncing from high school history to my own jaded view of the world – isn’t the “nationalization” (as in not reporting on local stories or politics) of modern media contributing to people caring more about federal politics over state or local politics?

        Do you feel like the increased mobility (as in bouncing from state to state for jobs) of modern Americans should have any effect on the power balance between state and federal governments?

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