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?

Source of evil

My blog received a big boost in traffic this week because, according to commenter Stephen (with minor corrections):

Founder of Crossfit had a talk in which he used rent-seeking as a reference and why that was bad for crossfit and against his business model which he likened to “Striving to excellence instead of striving to make money is a better way to run a business”

He then posted a link to a blog post I wrote in 2011 to distinguish rent-seeking (or as one of the excellent regular commenters here, Mike M, put it, “privilege seeking”) from capitalism. So, I’d like to thank the Founder of CrossFit, thank all who visited Our Dinner Table and thank to all who left a comment to advance the discussion — even those who disagreed with me.

I’m guessing he posted a link for rent-seeking because, as I point out in that blog post, so few people understand what rent-seeking is and the term itself is not intuitive.

Privilege seeking is a more intuitive term. Seeking privileges at the expense of others is about as spot on description as I’ve heard, so far.

Rent-seeking is using government to reduce consumer choices for the benefit of a special interest.

In my 2011 post, I used the sugar tariff as an example of rent-seeking. It works like this: Government adds a tariff to sugar imports, which results in a higher price paid for sugar products in the U.S. by consumers. The higher price benefits domestic sugar farmers who get to charge more since their foreign competitors’ sugar prices includes the tariff.

The objective of my previous post was to highlight that to the extent the tariff allows domestic sugar farmers to charge more, those profits are not earned through capitalism. But, too often folks see that as capitalism. In their eyes, profit and capitalism are almost interchangeable.

I’d like to commend the founder of CrossFit for shunning rent-seeking (it’d be great if he could hook me up with a set of pipe/monkey bars and maybe a small climbing wall for my basement :)). That means his strategy is to attract and retain customers by making their lives better, rather than using government to restrict their alternatives.

As it turns out, I happened to also listen to a Harvard Business Review podcast this week with guest John Mackey, Founder and CEO of Whole Foods Market. He has a new book titled, Conscious Capitalism.

capitalism

capitalism is actually beautiful (Photo credit: wallstalking.org)

In the podcast, Mackey describes his journey from spouting progressive to appreciative capitalist — and it sounds a lot like mine, except I haven’t founded any big companies, yet.

He discovered that how he viewed businesses when he was young — as greedy, singularly focused money-makers — wasn’t all true. He learned that businesses (usually) succeeded by providing something customers value, which is a tremendous overlooked (or perhaps taken for granted) benefit for society. It may be fun to hate on capitalism, but by gosh, don’t take away my iPhone, sort of thing.

But, I think Mackey misses something BIG. While I applaud Mackey and the Founder of CrossFit for eschewing rent-seeking and favoring customer value creation, i.e. for being capitalists, not all businessmen are capitalists.

One thing almost all business people have in common with the rest of us is that they are human. And one thing nearly all economists know about humans is they respond to incentives (though they differ in their beliefs by how much).

So, it follows that business people respond to incentives. They make more money when their companies do well. One way to guide their companies to success is through good-ol’ capitalism — providing the customer with products they value enough to buy.

But, another way for business people to make money is through rent-seeking. Whether it’s a sugar tariff that allows you to charge more or a state giving special tax breaks for auto plants to ‘attract jobs’, as government at all levels have gained more power, the value of rent-seeking has increased along with it. As Harry Browne put it:

Government is good at one thing: It knows how to break your legs, hand you a crutch, and say, “See, if it weren’t for the government, you wouldn’t be able to walk.”

You can blame greedy business people who are unlike John Mackey and the CrossFit founder for seeking profits without creating customer value, but you’d be blaming the wrong people. The right people to blame would be us, for letting government out of its cage to sell the power we give it to the highest bidder to do things like transfer $40/year of our money to rich, rent-seeking sugar farmers so they can continue to buy that power…with our money.

Think about that for a second, $40 isn’t much (which is why we’re not picketing in the streets about it). But, wouldn’t you rather use that $40 to buy something you value rather than give it to the sugar farmer so he can use it to keep getting it from you?

That’s a double-whammy. Whammy one: You lose your chance to buy something with that $40 that makes your life better. That value never materializes in society. Whammy two: Some of that money goes to do nothing more than to convince politicians to continue getting it. If you understand that, it shouldn’t be hard to see that shrinking government can help the economy.

Rent-seeking at the fair

This weekend, I’m helping sell goodies at a charitable fundraising booth at a local Labor Day weekend festival when I came across a good example of rent-seeking.

Rent-seeking is service that many lobbyists perform for their clients.  They lobby government to pass laws that protect their clients from competition, which allows them to charge higher prices and make more profit.  They often dress this up to be more politically palatable by justifying the laws as being good for the consumer.

Rent-seeking profits are often mistaken by the public as capitalist profits, when they are the opposite.  Rent-seeking profits are made by reducing consumer choice.  Capitalistic profits are made by consumer choice.

Anyway, back to the fair.

While working the booth, I learned that one of the major soda makers bought the rights from the festival organizers to be the sole soda provider at the festival.  So, each fundraising booth has to sell their products.

So, in this example consumer choice and competition is limited, while the festival organizers and soda makers benefit.

To be fair, this example does differ from the typical example of the government acting as the rent-seeking enforcer.  The festival organizers apparently add value by organizing the event, as evidenced by the tens of thousands of people who attend.  Since the consumers still have a choice whether to show up or not, their limited choice of soda must not make much difference to them.

But, it would still be nice to able to enjoy the soda I prefer along with my funnel cake, without having to smuggle it in.

Freeloader Index

I like Arnold Kling’s idea in this post on Econlog for a tax calculator.  Here’s how he describes his tool:

How about a tool that would show how much the government could afford if everybody paid the same amount of income taxes as you do? Suppose we have 150 million households. Based on the hypothetical household that pays $3683 in taxes, that gives roughly $550 billion for the government to spend on everything other than Social Security and Medicare. That’s even stingier than Rand Paul’s budget. A lot stingier.

The tool I have in mind would spit out, “On everything other than Social Security and Medicare, the government spends ___ times what it could afford to if yours was the typical household paying income taxes.” In the example, the blank would be filled in with a number close to four.

I like his idea.  This would give most everyone an idea of how much they demand to freeload off their fellow or future taxpayers.

The blank in the sentence would be your Freeloader Index.  The higher the number, the bigger the freeloader.  What’s your Freeloader Index?

Extreme Freeloaders

A blog comment I came across recently suggested a TV show be modeled after Hoarders to bring light to the dysfunctional and careless spending of other peoples’ that takes place in DC. I liked this suggestion.

Also, recently a new show has emerged, Extreme Couponing.  The funny thing is that it holds my attention.  The woman on last night’s episode paid $100 for over $1,800 worth of goods.  Oh, the drama of waiting for that total!  (I predict manufacturers might implement new coupon limits in response to the show).

Maybe Stossel could produce Extreme Freeloaders it.  It would be a natural extension from his Freeloaders special.

In it, he could trace all the bad incentives.  Politicians spend taxpayers money to peddle their influence with special interests and to make glowing claims in their election speeches.  Special interests lobby for the goodies.  Voters accept the status quo because everything is made to sound compassionate and things we ought to be doing (without the slightest consideration given to doing those things voluntarily).

Make it, take it

In the Wall Street Journal Opinion section today, Stephen Moore writes a slightly different take on rent-seekers or freeloaders in his piece called, We’ve Become a Nation of Takers, Not Makers.

His statistics are eye opening.

If you want to understand better why so many states—from New York to Wisconsin to California—are teetering on the brink of bankruptcy, consider this depressing statistic: Today in America there are nearly twice as many people working for the government (22.5 million) than in all of manufacturing (11.5 million). This is an almost exact reversal of the situation in 1960, when there were 15 million workers in manufacturing and 8.7 million collecting a paycheck from the government.

And, it’s not just manufacturing.  Moore takes a closer look at states known for other things:

Iowa and Nebraska are farm states, for example. But in those states, there are at least five times more government workers than farmers. West Virginia is the mining capital of the world, yet it has at least three times more government workers than miners. New York is the financial capital of the world—at least for now. That sector employs roughly 670,000 New Yorkers. That’s less than half of the state’s 1.48 million government employees.

Moore goes onto to discuss something near and dear to my heart — managing inputs rather than outputs, which leads to declines in productivity:

After setting the table to show that productivity (i.e. output per employee) has increased dramatically over the last several decades in the private sector, Moore writes:

Where are the productivity gains in government? Consider a core function of state and local governments: schools. Over the period 1970-2005, school spending per pupil, adjusted for inflation, doubled, while standardized achievement test scores were flat. Over roughly that same time period, public-school employment doubled per student, according to a study by researchers at the University of Washington. That is what economists call negative productivity.

But education is an industry where we measure performance backwards: We gauge school performance not by outputs, but by inputs. If quality falls, we say we didn’t pay teachers enough or we need smaller class sizes or newer schools. If education had undergone the same productivity revolution that manufacturing has, we would have half as many educators, smaller school budgets, and higher graduation rates and test scores.

And we may yet see that with innovations like Khan Academy.

A better term for rent-seeking

John Stossel has a more intuitive term for economic rent-seeking (which I wrote about here, here and here).

His term is freeloading.

His latest FoxNews television special goes by the title Freeloaders and he too harps on GE for using rent-seeking, or freeloading, as a business strategy.

He also runs the gamut on the freeloading and gives illustrative examples that includes street beggars (he tests whether the ‘will work for food’ signs are truthful), farm subsidies, green energy and corporate welfare like GE.

Stossel says that GE declined to be interviewed for the show.  Too bad.

Stossel did show footage from an interview with a CEO of an ethanol company that agreed to be interviewed when Stossel covered the same subject 13 years ago.  The CEO said:

Why should I care?

I agree with that CEO.  See my previous post.  He shouldn’t care. If the government offers a benefit he’d be stupid and out of a job if he passed on it.  He’s only responding to incentives and he’s probably responding to them very much like many of us would.

Several of Stossel’s guests do touch on where the blame lies.  With us.

We’ve allowed a system to emerge where hundreds of millions, if not more, is spent on lobbying by special interest groups that are looking to freeload.

They’re either looking to get a direct piece of the immense flow of taxpayer funds or they’re looking for government to grant them an advantage that will very likely favor that company and hurt consumers, though it will spun as the opposite.

Rent-seeking is not capitalism

Rent-seeking is the bad profit seeking activity that people often mistake and confuse for capitalism.

I think rent-seeking is one of the most unintuitive terms in economics.  Few people know what it means and the words don’t lend themselves to easy interpretation.  Rent-seeking brings to mind images of landlords, which is incorrect.  Maybe someone can coin a more intuitive term to replace it.

We would be better off if more of us could properly recognize rent-seeking activity and distinguish it from capitalism.  Then many things that are claimed to be “failures of capitalism” could be blamed on the real culprit, rent-seeking.

So, what is it?

Rent-seeking a genteel way to say attempted robbery.   Here’s the wikipedia description of rent:

Rent… is obtained when a third party deprives one party of access to otherwise accessible transaction opportunities, making nominally “consensual” transactions a rent-collection opportunity for the third party.

That doesn’t help much, does it?  An example might.

We pay more for sugar (a nominally “consensual” transaction) because the U.S. Federal government (third party) imposes a tariff (deprives access to otherwise accessible transaction opportunities) on sugar imports  to protect domestic sugar growers.   U.S. sugar growers cannot produce sugar as cheaply as foreign producers.  The tariff raises the price we pay for foreign sugar so U.S. sugar can compete.

That’s like government forcing Walmart to raise prices to make Target more competitive.  Sounds good to Target, but Walmart customers would not like it.

Based on some quick Googling, sugar tariffs cost my household $20 – $30 per year.  Not a lot, but enough.  If I didn’t spend that money on sugar I might spend it on an extra restaurant meal or even higher speed internet.

Rent-seeking comes in many forms.  A common form is special interest groups lobbying to use government power that forces others to do something — like pay tariffs or use only union workers — to benefit the members of the special interest group.  Often such things are sold to the public as ways to “protect” consumers.  Little do consumers know how much that protection truly costs them.

Just about every lobbying effort in DC or at your local state house is an effort by some special interest group to harness a bit of that government power to their own advantage.  Even the politicians who auction off the power vested in them by the voters are rent-seekers.

Even your local pro sports franchise rent-seeks.   How do you think stadiums are built?

Rent-seeking is not capitalism.  Capitalism is nothing more than the private ownership of capital.  In capitalism people seek profits by trading voluntarily and for mutual benefit.

Rent seekers profit from coercion and transactions that may not result in mutual benefits to all involved.   That makes people angry, so it should.  But it also gives capitalism a bad name, which it shouldn’t because that’s not capitalism.

It’s important to recognize that rent-seeking is not unique to capitalism.  It happens in every form of economy.

Update: @Anonymous: You may be interested in reading my post, What is capitalism?