Thursday, February 10, 2011

The Nature of Rent Seeking

Last week I wrote about the field of Public Choice, which is the application of economics to the political process. One of the best known ideas from Public Choice concerns "rent seeking". This blog post is a riff on a recent Econ Talk podcast with Mike Munger and Russ Roberts.

David Henderson breaks down the term "rent seeking" in the Concise Encyclopedia of Economics

David Ricardo introduced the term “rent” in economics. It means the payment to a factor of production in excess of what is required to keep that factor in its present use. So, for example, if I am paid $150,000 in my current job but I would stay in that job for any salary over $130,000, I am making $20,000 in rent. What is wrong with rent seeking? Absolutely nothing. I would be rent seeking if I asked for a raise. My employer would then be free to decide if my services are worth it. Even though I am seeking rents by asking for a raise, this is not what economists mean by “rent seeking.” They use the term to describe people’s lobbying of government to give them special privileges. A much better term is “privilege seeking.”

That is a good explanation and jives with the popularity of the idea in Public Choice. But, the hallmark of rent seeking is that it is a contest. Each person in the contest allocates resources towards the goal of winning the contest. Whether they win the contest or not the resources have been spent. These exercises cause resources to be spent in unproductive ways. Yet, these contests exist beyond government lobbying for the right piece of legislation. These contests also exist in patent races for technology between private firms. What makes the rent seeking for the right legislation and technological races different? Discovery and Feedback.

When firms in the market compete in a contest to have the best technology new products are discovered that improve the lives of consumers.  These contests can sometimes be pretty risky. Firms do not necessarily know in advance how valuable a product could be. But, if those products are not valuable to people the firm will receive "feedback" from the market that what they are selling is not in demand. Then, they will go back to the drawing board to try to invent new products that are valuable. There is some waste in the discovery process because not everyone who allocated resources is rewarded for their invention. Firm competition, however costly, ultimately leads to consumers being able to purchase goods that are valuable to them. Because consumers can discipline firms they can direct innovation.

On the other hand, I'm having trouble understanding what contests over legislation discover. Also, I'm having trouble understanding how the feedback works in the political process. This is a topic for another day.

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