May 30, 2012 columns

An Introduction to Rent Seeking

Samples explains how consumers are harmed by corporate rent-seeking with a look at New York City taxi licensing.

Many consider rent seeking a vital contribution of public choice economics. This brief essay will explain rent seeking and its importance to economics and politics.

Most of us are familiar with the term “rent” as in “I paid the rent on my apartment.” Here the rent in question is the return on a productive resource (housing). Economists refer to an economic rent as a return to the owner of a resource in excess of what might be expected under normal competition. Market competition tends to reduce such rents; high profits attract new entrants who offer lower prices or better value for the same goods and services.

Government can create an economic rent by limiting market competition. New York City, for example, limits the number of taxis to 13,000 or about half as many as during the 1930s when the city’s population was smaller than it is now. The cap on taxis prevents new entrants, thereby protecting the profits of incumbents. The value of such protection should not be underestimated. A license to operate a taxi in New York recently sold for over $1 million.

Who is harmed by government providing economic rents? Consumers are harmed. Given the limits on competition, riders must pay more for taxi rides in New York than they would under open competition. People who might have driven a cab absent the licensing also lose out. The economic rents provided to taxis by government also cannot be spent on other goods or services. The people who would have offered those goods and services are worse off than they would have been absent the licensing. The limit on cabs thereby distorts the economy and harms many people, many of whom are not obvious.

Some people do benefit from economic rents and therein lies the problem of reform. The owners of a license gain the right to abnormally high profits. The public officials who grant the freedom from competition receive votes, electioneering efforts, and campaign contributions from the taxi industry. Everyone in the industry has a clear material interest in continuing the licensing whatever its effects on everyone else.

Some people say that removing the power to offer rents would avoid rent seeking. If government did less, officials would have fewer economic rents to offer leading in turn to less rent seeking and less damage to society. True enough. But existing laws and regulations cannot be wished away. We need a political solution to rents.

Imagine that by chance or design a New York mayor decided to eliminate taxi licensing. The industry would lose all the benefits noted above; in particular, owners would lose the value of their license, which depended on the protection from competition. They would have one million reasons to resist reform and would quickly organize resistance to the mayor’s proposal. Protests would fill the evening news. Poor service would be predicted. The sad plight of the cabbie would be discussed.

But, you say, what about the winners? Wouldn’t they rally to the side of reform? After all riders would pay less to get across town. Other people suffer in various ways from the licensing.

Probably not. In New York, many taxi riders would be from out of town. The businesses who would benefit from diverting dollars away from overpriced cab rides do not exist and thus cannot lobby the city government. Even those riders who live in New York would gain at most a few hundred dollars if the licensing disappeared.

Government responds to organized interests. Taxi owners have a lot to lose and thus sufficient motivation to pay the costs of organizing and influencing public decisions about taxi licensing. Taxi riders are different. The costs of organizing for them are likely higher than the gains from less expensive rides. Taxi licensing persists despite imposing aggregate costs on many New Yorkers.

Rent seeking involves other costs to society. The economic rents provided by the government are not economically productive. The resources spent seeking to persuade officials to grant an exemption from competition to an organized interest are wasted. This waste includes not only money but also the diversion of talent and time into rent seeking. Smart lobbyists might have done something more productive with their brains and their time.

Those who see government officials as benevolent seekers after the general welfare have a hard time accounting for rent seeking. It is not enough to say that bad people in office should be replaced by a better sort. The incentives created by awarding rents to organized groups would remain when the better sort arrive.

The idea of rent seeking tells us to be skeptical of government, pessimistic about reform, and morally outraged about the status quo.

 

Further Reading

Eamon Butler. Public Choice – A Primer. London: Institute of Economic Affairs, 2012.

Mancur Olsen. The Logic of Collective Action: Public Goods and the Theory of Groups (Revised ed.). Cambridge: Harvard University Press, 1965.

Gordon Tullock, “The Welfare Costs of Tariffs, Monopolies, and Theft ,” Western Economic Journal, 5(June 1967)224.