January 23, 2003

Chapter 16

Rent Seeking

Public Choice begins with two assumptions: (1) that members of a collective have demands for public goods and (2) that they believe they can better satisfy their demands by making a collective agreement. Members are immediately confronted with high costs of making collective decisions. To avoid or reduce these costs, they agree on a rule of less-than-unanimity for making laws. In addition, they elect agents (legislators) to make laws in their behalf. This combination gives people an incentive to try to influence the actions of legislators and enforcers. Sometimes people try to influence politicians to make laws (or administrators to enforce laws) that will facilitate trade and, as a consequence, be beneficial in general. However, people also promote laws and administration that they expect to benefit themselves at the expense of other members of the collective. Actions of this sort are called rent seeking.

Rent seeking pertains to laws and/or administrative actions that most people would regard as harmful, or wasteful, in net. There are two kinds of such laws or administrative actions. The first grant special market privileges to some people while taking privileges away from others. The second redistribute wealth. Thus we distinguish between two kinds of rent seeking: (1) market privilege rent seeking and (2) redistribution rent-seeking.

     Trying to influence laws and their administration is part of the ordinary activity in a democracy. When you vote, you hope to elect a candidate who will vote for laws that are in your interest. And, if you are a typical voter, you probably pay very little attention to whether those laws harm others. However, ordinary voting is not rent seeking. Rent seeking consists of legitimate, non-voting actions that are intended to change laws or administration of laws such that one individual and/or group gains at the same or greater expense to another individual or group.

     Consider a real-world example. Suppose that a U. S. steel company is losing money because of competition from Asian or European steel. Suppose further that the company bosses believe that they can eliminate the losses in two ways. First, they can modernize by building a new factory. Second, they can hire a lobbying company and make campaign contributions to legislators in order to persuade them to pass a law blocking imports of foreign steel. If the lobbying and campaign contributions cost less than the factory, the company would choose the lobbying.

     If the lobbying succeeds, people in the society would be worse off for two reasons. First, there would be an increase in the price of steel. In the typical economic model, this means inefficiency because the benefits to the gainers are less than the losses to the losers. Second, resources that would otherwise be used to produce useful products would have been used in activities intended to produce the law. In other words, the resources used to promote the law would be wasted.

     This kind of choice confronts many large companies today in the more developed democracies. The result is a large lobbying industry. The lobbying industry is even larger than otherwise because of what we might call defensive lobbying. This is lobbying aimed at avoiding the harm that other peoples' lobbying and other rent seeking actions are likely to cause.

     In the U.S., many large firms make a contract with a professional lobbying firm or they hire people directly in order to influence legislators, the president, and voters. In the newer democracies, the relationship between politicians and firms is often more direct. The companies simply bribe the politicians or assure with their campaign contributions that the politicians are reelected, that their families are cared for, etc.

     We define rent seeking to be a legal act. Accordingly, if bribery is illegal, the act of bribing a legislator to vote for a law is not rent seeking. In some societies, however, the distinction between the legal and illegal acts is not so clear. Where bribery laws exist but are not enforced or are not enforced vigorously; the boundary between legal and illegal actions is not sharp. In this case, it is not easy to distinguish legitimate rent seeking actions from corruption.

      In economic models, we can define rent seeking precisely. This is because we can define efficiency precisely in our models. In practice, it is not so easy to tell the difference between rent seeking and other actions that aim to influence laws.

     In everyday life rent seeking can become extremely complex and each case is different. We cannot describe it fully here. Our purpose in this chapter is to describe the basic idea and to give some simple examples. Parts one and two discuss rent seeking that is aimed at achieving market privileges. This is the kind of rent seeking about which Public Choice scholars have written the most. Part one presents two types of market privilege rent seeking: the case of a single firm wanting a monopoly and the case of domestic firms wanting protection from foreign competition through a tariff. Part two uses Buchanan's example of taxi services to illustrate different levels of market privilege rent seeking. Such a procedure is necessary in order to analyze more complex rent seeking cases. Part three presents an example of market privilege rent seeking. Part four describes redistribution rent seeking.

1. THE ANALYTICS OF RENT SEEKING

     The term "rent seeking" comes from the idea in economics of "monopoly rent." Monopoly rent is income earned by an individual because he is able to charge a monopoly price. Most people believe that monopoly is bad. Indeed the most developed countries have laws that prevent firms from "acting monopolistically." However, economists have long taught that monopoly can benefit consumers. It can be a reward for previous entrepreneurial activity. Without the prospect for a monopoly price, no one may decide to make a particular good available for sale or to invest in a particular kind of research. Recognizing this, members of the collective typically want their government to award a patent monopoly to people who discover new products or methods of production.

     When economists refer to the negative effects of monopoly, they purposefully disregard the reward it provides for entrepreneurship. They shift their attention to the possibility that a monopolist may not sell to a consumer even though his marginal cost is lower than the price the consumer is willing to pay. An example is a company that buys out its competitors for the sole purpose of raising its price.

      Imagine a small town with only two people who are specialized in repairing cars. Assume that they are equally efficient producers of the service. At first they are competitors. Each consumer benefits from the competition. If one producer tries to charge a price that is higher than his cost, a consumer can make a deal with the competitor. The competitor will accept the deal because (a) we have assumed competition and (b) she can increase her profit by doing so. In the economic model of competition, each competitor tends to reduce price to the point where it equals her additional, or marginal, cost of production.

     But now suppose that one of the firms buys the other's right to do business. Then it becomes the only seller -- a monopoly. The monopolist can then raise his price above his marginal cost. As a result, some prospective consumers of car repair service will choose not to buy the service even though they are willing to pay a price that is higher than the monopolist's cost of supplying it. The monopoly buyout would cause inefficiency.

     In practice, the prospect for monopoly rent from a monopoly buyout is usually limited to a short term, unless the government lends a hand by prohibiting competition or by burdening competitors with special restrictions. So long as people are free to open new businesses to compete with the old, a monopoly price is a signal that a new business is profitable. In our example, after the one repairman shuts down and the remaining one raises the price, another person will have an incentive to acquire the training needed to open a competing repair shop. In a pure market economy, where everyone is permitted to start a new business, monopoly rent of this sort cannot last.

     Strictly speaking, monopoly means a single seller. And monopoly rent refers to the profit earned by such a seller. However, a price that is similar to the monopoly price may exist even though there is more than one seller. When farmers succeed in persuading the legislature to impose a special tax on cheaper imports, the prices they can charge for their own goods rise. The farmers may compete among themselves in their own country. Nevertheless, the law puts foreign suppliers at a disadvantage, enabling domestic suppliers to charge a higher price. The additional profit of the farmers is in the same class, from the Public Choice perspective, as monopoly rent. This similarity has led Public Choice writers to include actions like the farmers’ efforts to block imports in the rent seeking category.

Example 1: The Pure Monopoly

     Economists usually use mathematical models to illustrate pure monopoly and monopoly rent. However, the idea is simple enough that we really do not need the mathematics. Suppose that there are several competing sellers of hot tea at a popular park on a cold winter day. Suppose further that anyone is free to enter the tea business. We refer to the interaction among the tea sellers under these conditions free competition. Under these conditions, we would expect the price of tea to be rather low. In fact, the price would tend to be only slightly higher than the cost of the materials and other resources needed to supply the tea. If it was much higher, additional sellers would be attracted into the business. Of course, unexpected changes may enable tea sellers to enjoy unusually high profit for a time or it may lead them to incur unusual losses. However, freedom of entry and exit from the tea business would tend to cause profits to be comparable with the income that these tea sellers could earn in their best alternatives. On the other hand, if there was a strict law giving the tea monopoly to only one company, and if the company was free to charge whatever price it wanted, we would expect the price to be quite a bit higher.

     By comparing these two cases, we can deduce the effects of the monopoly on consumers. To do this, it is convenient to divide the consumers into two groups. The first are the consumers who decide to buy even though the monopoly price is higher. In relation to competition, the monopoly would result in a transfer of wealth from these consumers to the tea seller. Money that they could have spent themselves would now be transferred to the tea seller. Economists call this a “wealth redistribution.”

     The second group is comprised of consumers who decide not to buy. They do not lose any money. However, they lose an opportunity to buy. Resources that would otherwise be used to produce tea are used elsewhere in the economy. By refusing to sell at a lower price, the monopolist blocks resources from being transferred into the tea industry, where they are more valuable from the standpoint of consumers. This harms the consumers who choose not to buy and the owners of specialized resources, who would, under free competition, be paid more by producers because of the higher quantity that producers would produce. We call this loss in value an efficiency loss.

     In short, monopolization and the subsequent charging of a monopoly price has two effects: The first is a redistribution of wealth from some consumers to the monopolist. The second is an efficiency loss due to the transfer of resources from a higher-valued use to a lower-valued use.

Market Privilege Rent Seeking

     As we pointed out earlier in the chapter a person may try to attain a monopoly position by buying out his competitors. Although these cases are interesting to economists, Public Choice is not concerned with them. Public Choice is only interested in cases where a monopolist achieves his position by obtaining monopoly privileges from government agents. In these cases, we say that an individual seeks the privilege of being able to earn a monopoly rent from an agent of the government. Examples are the monopolies and laws restricting competition that result from contributing to legislators' campaigns, from lobbying legislators, or from bribery.

     In these examples, rent seeking refers to the actions that an otherwise competing firm might take to achieve the market privilege. For example, one of the tea sellers in the park may hire a former politician to persuade legislators that competition in tea selling will result in defrauded customers, "inferior" tea, unstable tea prices, and too many unsightly sellers. To avoid these things, the government should grant a monopoly franchise to his company; since it is well established, reputable, and unsightly.

Rent Seeking Investments by Potential Monopolists Under Complete Certainty

     If there is a prospect for attaining monopoly rent, prospective recipients of rent will have an incentive to invest resources in rent seeking. This may be a source of wasted resources that must be added to the efficiency loss. Let us call the money that people invest in rent seeking the investment cost.

     To get an idea of the situation faced by potential rent seekers, we might think of the monopoly rent as a prize. If any one firm can attain a monopoly, it will receive this prize. The prize comes at the expense of two groups: (1) consumers, who can expect to pay a higher price in the future, and (2) rival suppliers, who lose opportunities to sell. A firm would invest resources to obtain the prize up to the point where the expected marginal benefit is no longer greater than the marginal investment cost.

     Imagine the owner of a firm that is now operating in a highly competitive industry. She is just breaking even. Now assume that she perceives a rent seeking opportunity. If she succeeds in her rent seeking, she expects the monopoly rent to be a fixed amount of money, say $M, each month. Suppose in this first case that she is absolutely certain of attaining the monopoly position as a result of her contribution to the campaigns of several legislators. Then she would, at the maximum, be willing to invest an amount equal to the capitalized value of $M per month, say $CM. If conditions required her to invest a slightly smaller amount than $CM, say $X, she would do so.

     The waste of resources due to the investment in rent seeking in this example depends on how the aspiring monopolist uses the $X. Suppose that she uses it to try to persuade voters to vote for a selected set of legislators in the next election. Then she would hire professional campaign workers, thereby diverting these workers away from other market economy jobs where they would have produced goods for consumers. In this case, there would be a waste due to rent seeking of almost the whole amount of $X. The reason is that almost $X worth of consumers’ goods will not be produced as a result of the rent seeking investment.

     We define the net market privilege rent seeking loss as (1) the efficiency loss plus (2) the investment cost plus (3) the costs incurred by the government to restrict competition plus (4) any costs incurred by individuals or firms for defensive rent seeking (see below) minus (5) the part of the investment that is received by government officials. In this example, the net rent seeking loss would approximately equal $X of investment cost plus the monthly efficiency loss to consumers who do not buy the good due to the higher monopoly price. In addition, some police resources may have to be used to restrict competition. This is because the police must be used to threaten the would-be competitors with punishment. There are no costs of defensive rent seeking in this example. Also, no money is received by government officials. In short, the net rent seeking loss is (1) plus (2) plus (3) in the above list.

     Now suppose that $X is used to pay a bribe to the chief executive. As a result, the chief orders his police to prevent any other firms from competing. Assume that the chief executive's activity is not illegal. In this case the net rent seeking loss consists almost entirely of (1) and (3). The money invested by the firm is not used to buy resources. (2) is canceled out by (5) and resources are not diverted from other uses. The money is merely transferred to the chief executive. There is a small additional loss due to the costs of carrying out the transaction between the would-be monopolist and the chief executive. We may wish to count this as an investment loss that is not offset by money received by government officials or we may wish to develop an additional class that would contain losses due to transactions costs. In this case also, there are no costs of defensive rent seeking.

     There are many examples in the history of policing in the older democracies where the police actively solicited bribes in order to protect a firm from competition. In the more mature democracies that have a commitment to free enterprise, we do not see much of this activity today except in the case of illegal services, like drugs and prostitution. Such activity is more common in new democracies, where the police have not customarily been under democratic control and/or where the commitment to free enterprise is less strong.

Uncertainty Faced by Rent Seekers

     In our example we assumed that the rent seeker is certain of achieving her goal of attaining the monopoly. Suppose that she believes that she has only a one-in-ten chance of persuading legislators to grant her a monopoly. Then, disregarding a possible aversion to or thrill of risk, she should be willing to spend only $CM/10. If she is unsuccessful, consumers of the product would not lose anything. There would be no efficiency loss. However, if the $CM/10 is used for lobbying or to hire campaign workers, it would be wasted. There would still be some net rent seeking loss in the form of investment loss.

     It is possible that more than one firm would compete for the rent seeking gains. Imagine, for example, that the government is considering the applications of ten different firms for the status of monopoly supplier. Each firm might calculate that its probability of being selected if it expends resources for rent seeking is one out of ten. Then each of the ten firms may be willing to spend up to $CM/10. In this case, the total spending could be near $CM. If one or more of the firms made a mistake and overestimated its chances of success, the amount spent could actually be higher than $CM. Thus it is possible that the investment loss would exceed $CM.

Consumer Reaction to Rent Seeking

     We have so far assumed that consumers are passive bystanders who have no concern with how legislators vote. This, of course, is not true. Consumers who want lower prices have an incentive to join together in order to persuade legislators not to permit a monopoly. To the extent that they do so and are successful, they will reduce the monopoly rent that rent seekers expect. a prospective monopolist's expectation of this would probably reduce the investment in rent seeking. Note, however, that for this to occur, consumers must themselves invest resources. If the investment is in the form of resources used for persuasion, they should be included as part of the rent seeking loss.

     We can call the actions of individuals or firms that are intended to avoid harm due to the rent seeking of others defensive rent seeking. It corresponds to what we called defensive lobbying in the introduction. Defensive rent seeking costs are wastes of resources due to defensive rent seeking. They are comparable to the investment costs described above, except we assume that they would not exist if it were not for the rent seeking.

     Another point to consider is collective decision-making costs. Ordinarily there are many consumers, each of whom would gain only a small amount from blocking the rent seeking. Consumers face a free rider problem. But there may be only one firm seeking the monopoly privilege. If so, no free rider problem would exist on the seller's side. Applying the lesson we learned in Chapter Twelve on pressure groups, the advantage would ordinarily go to the rent seeker. In fact, each consumer may regard her personal benefit as so low that she would be unconcerned. There may be no defensive rent seeking.

Example 2: The Import Tariff

     Now consider a more complex case in which there is no actual monopoly, only an increase in market price due to a restriction on potential competitors. Specifically, consider the case of an import tariff. Suppose that the world price of some commodity, say a particular type of rice, is w. If there was no tariff and no other restriction on the distribution and sale of foreign products, the price in the domestic market would be close to w. Let us suppose that w is high enough so that some domestic rice farmers find it profitable to produce and sell in the domestic market. Specifically suppose that they produce a quantity q_d. The rest, let us say q_f, is supplied by foreign rice producers. Assume for simplicity that there are no rice exports and that all rice of this type has the same quality.

     Suppose now that rice producers at home join together in a pressure group. They go on to persuade legislators to impose a tariff on each kilo of imported rice. Assume that the tariff is completely effective (in other words, there is no smuggling of non-tariffed goods). Then the domestic price of all rice would rise to meet the sum of the world price plus the tariff. Other things equal, the higher domestic price would reduce the quantity of rice bought and sold in the country. This is because some consumers would decide that they could not afford to buy as much and some consumers would shift to substitutes.

     Although the total quantity of rice sold in the domestic market would fall, the amount produced and sold by domestic rice producers would rise. In short, q_d + q_f would fall, q_d would rise, and q_f would fall by a greater amount than the rise in q_d. Consumers would be worse off due to the higher price.

     To deduce the effects of the rent seeking in this case, we must divide consumers into groups, as in the case of the pure monopoly. Unlike that case, however, we must further subdivide the group that decides to buy, even though the price is higher, into two sub-groups: those who buy from domestic producers and those who buy from foreign producers. We begin with those who buy from domestic producers. For these consumers, there is a redistribution of wealth to domestic producers, as in the case of the pure monopoly. However, the redistribution is not complete. Because rice farmers have no monopoly in domestic rice production, the higher domestic price leads to more domestic competition, which bids up the price of resources used by domestic rice producers. Because of higher costs, rice producers gain less than the consumers lose. This is a kind of efficiency loss, since resources are shifted from other uses where consumers value them more highly. In other words, the money that is lost by this first subgroup of consumers is partly redistributed to domestic farmers but also partly wasted, since resources that would otherwise be used to produce more valuable goods are shifted into rice farming.

     Now consider the second subgroup. These are consumers who buy from foreigners at a higher price. The foreign producers continue to receive the same price, w, for their rice, yet the consumers pay more. The difference is tariff revenue. Thus, the money is redistributed from the consumers to the tariff department of the government. The identity of the people who actually gain from this depends on how the tax revenue is used. Two possibilities are that the tariff revenue would be used (a) to reduce other taxes or (b) to pay for other government programs.

     The third group are the consumers who choose not to buy rice because of the higher price. Their loss is an efficiency loss. Resources of the rice exporting countries that could be used to satisfy the wants of consumers for rice are used elsewhere to satisfy wants that are less important in terms of money to others who have them.

     In sum, there are two classes of efficiency loss: (1) resources that are more valuable elsewhere in the domestic economy are shifted into rice production and (2) the opportunity to buy cheap foreign rice is lost to the consumers who choose not to buy at the higher price.

Two Sets of Gainers

     Unlike the first example, there are two sets of gainers from the tariff: (1) rice producers and (2) beneficiaries of the additional government revenue. A variety of people might gain from the additional government revenue. Suppose, for example, that legislators vote to substitute the tariff revenue for income taxes. Then the reduced income tax would enable payers of this tax to gain. Alternatively, suppose that legislators vote to earmark the tariff revenue for a specific project, say building a set of municipal parks. Then the suppliers and demanders of the park services would gain. A third possibility is that tariff collectors, bureaucrats, or politicians could either pocket the money or use it to enhance their wealth or well-being in some indirect way. In this case, these government officials would gain.

     It is worth noting that the tariff will harm foreign producers of rice. If foreign governments become aware of this, they may retaliate with tariffs of their own. In this event, foreign tariffs would harm domestic producers of some other good.

     Strictly speaking, the rice farmers do not have a monopoly. Nevertheless, so long as they make campaign contributions, persuade, or pay bribes in order to achieve protection against competition; we say that they are market privilege rent seekers.

     Like the firm seeking a monopoly in the first example, the rice farmers here have an incentive to pressure politicians to exclude potential competitors. If the group of farmers faced no costs of collective decision-making (see below), it would be willing to invest up to an amount that is slightly less than the expected gain from the higher price of rice. We can make a similar statement about the people who expect to benefit from the tariff revenue. They may also have an incentive to invest in rent seeking.

Collective Decision-Making Costs

     There is an important difference between this case and the case of a monopoly. A monopolist is a single decision-maker. She may incur costs of making decisions but her costs are personal. When rice farmers act collectively, they incur not only personal costs but also costs of making collective decisions. When collective decisions must be made, there is a free rider problem. As a result, some rice farmers are likely to decide not to join with the others in a pressure group.

     Many governments have laws that give farmers of specific products an incentive to have meetings in order to share information about technology and other things of common interest. An example is a government grant to a university to carry out farm research and then to distribute the results to farmers by meeting with groups of them in seminars. Such programs have the side effect of reducing the costs of collective decision-making to the farmers. Once the farmers are assembled at the seminar, they can proceed to discuss the advantage of pressuring legislators or administrators.

Consumer Reaction

     Rent seeking by the farmers could face opposition. Consumers in the rice industry stand to lose. Whether they could form an effective opposing pressure group depends on their costs of collective decision-making. Suppose that the number of consumers is large and that the gain to each one from defensive rent seeking is small. Suppose also that the number of rice producers is small and that the gains to each one is large. Then the farmers may be able to form an effective pressure group but the consumers could not decide to engage in defensive rent seeking.

Net Rent Seeking Loss

     Let us now look at the net rent seeking loss. First, it consists of the two efficiency losses described above. Second, rice farmers may decide to hire a lobbying organization or they may use their own resources in an effort to persuade politicians to support the tariff. If so, the resources used are wasted. The investment in rent seeking becomes part of the rent seeking loss. Third, if the beneficiaries of the tariff revenue use resources to try to influence politicians, those resources will also be wasted. On the other hand, if the farmers or tariff beneficiaries pay bribes, the investment loss may be low. There would only be a redistribution of spending power. The second and third components of the net rent seeking loss should include the collective decision-making cost. Fourth, if consumers invest in defensive rent seeking, additional resources may be wasted. Finally, additional resources must be employed to enforce the tariff by deterring smuggling. These resources are also part of the total rent seeking loss.

2. CLASSIFYING RENT SEEKERS:

AN EXAMPLE OF TAXIS

     Buchanan has written an interesting paper that we can use to classify rent seekers. He imagined a city government that has the authority to grant taxi licenses. He further assumed that the law against taxiing without a license is strictly enforced at no cost. We can increase our understanding of rent seeking by following his logic.

Taxi Drivers as Rent Seekers

     To understand the example, we assume that there is a city government council consisting of elected politicians. The council grants licenses to anyone who meets certain minimum requirements and who pays a small license fee to cover administrative expenses. Assuming that demand for taxi service is high and that the cost of supply is low, there would be many licensees. Competition and competitive prices would prevail. Assume that each year, as the city grows, the demand for taxi service is met by more and more individuals who apply for and receive licenses to operate as taxi drivers. Now suppose that at some point, the taxi drivers who currently have licenses join together in a pressure group. They are able to persuade the government to pass a bill that freezes the number of licenses at its current number. No more licenses are permitted. As the years pass, the demand for taxi service continues to increase. Because of the limited supply, the price of taxi service rises above what it would have been if the bill had not passed. Under these conditions, the drivers who already have licenses would begin to earn monopoly rent derived from high taxi service prices. Their monopoly rent is similar to that of the rice producers in our second example. We may assume further that because drivers grow old or want to shift professions, the city council permits a retiring driver to transfer his license to a newcomer, provided the newcomer meets the minimum requirements.

     Notice that the growth in demand coupled with stagnant supply will have made the taxi license a valuable asset. To see the significance of this, consider a retiring driver who decides to sell his license. He would have to give up his share of the monopoly rent throughout the indefinite future. However, he can be confident that a buyer would compensate him for this loss. A buyer would anticipate earning a stream of monopoly rent. Presumably there are many prospective buyers since there are many people who can drive taxis. Since these people would bid for the license, we would expect that the price of the license would be only slightly lower than the capitalized value of the monthly monopoly rent expected by a new driver.

     Let us assume that the original taxi drivers anticipated that the law restricting taxi licenses to existing drivers would create this valuable asset for them. Then they would have had an incentive to form a pressure group to cause the law to be passed. If they had formed such a group, they would have been rent seekers. If there were no costs of collective decision-making and if they were certain that their rent seeking efforts would succeed, they would have been willing to invest an amount that is slightly less than the capitalized value of all the licenses.

     Now we want to introduce the possibility of other rent seekers. To do so, we shall add a second step. Suppose that after a few years, the legislators decide to take control of the licensing process. They pass a new bill. The bill still requires taxi drivers to have licenses but it establishes a city taxi commission to decide which license applicants will be approved. In other words, the bill annuls all existing licenses. The commission may choose to grant a license to an old license holder. Or it may choose to replace him with a new driver. In short, the law directs commission members to choose who will receive the licenses. The aim of the bill is to transfer the taxi license rights from their current owners to the members of the taxi commission. The city council expects the members of the commission to distribute the rights to “deserving” applicants for licenses. Assume that the total number of licenses granted stays the same.

     In actual cases where taxi commissions are appointed, the commissions are also typically given authority to control the price of taxi rides. In order to focus on rent-seeking, we shall assume that they allow the price of taxis to be determined by the taxi drivers who compete against each other for customers. Because there is no change in the number of licenses, the monopoly rent would continue. The number of licenses demanded by taxi drivers would be much greater than the number allowed by law. New applicants would compete with previous license holders for licenses. As a result, the commission would have to decide on some method to ration the limited number of licenses.

     Under these new conditions, prospective taxi-drivers would again be rent seekers. To see how, suppose that the commission holds hearings in which they invite applicants to testify on their deservedness. Some drivers might be certain at the outset that they would be regarded as deserving. Others might be certain that they would be regarded as undeserving. But there would be competition among those who were uncertain. Each would have an incentive to invest resources in his effort to persuade the commission that he is more competent than other applicants. We do not know exactly how much they would invest, partly because we do not know how uncertain the different applicants would be. At the extreme, if everyone was uncertain, the amount invested might be close to the present capitalized value of the expected monopoly rent. In any case, the taxi drivers would again be rent seekers. And they would invest money and time in an effort to obtain licenses. Thus there would be a rent seeking investment cost.

Commission Members As Rent Seekers

     Next, suppose that the city council allows the commission to decide the size of the license fee. Suppose further that it allows the commissioners to keep whatever monies they receive from selling licenses. A sensible city council would never do this because if it did, informed voters would surely vote the members out of office in the next election. But we can learn some things about rent seeking by considering this possibility.

     Under these assumptions, the members of the commission would have an incentive to auction taxi licenses to the highest bidders. Assuming that taxi drivers do not conspire to rig the auction, the amount bid for each license would be very close to the capitalized value of the license. And the sum of the highest bids for all the licenses would approximate the total amount of monopoly rent. Some amount of resources would be used up in conducting and participating in the auction, of course. Taxi drivers, for example, would have to spend some effort to calculate the price they should bid. Thus the sum of the highest bids would be somewhat less than the monopoly rent.

     The individuals who win the auction would obtain licenses and charge the high market price for taxi rides. However, their profit would not be significantly higher than it would have been if the license bill had not been passed in the first place. The reason is that they would have to pay the high auction price to obtain their licenses. They would earn monopoly rent but they would have already paid out almost the same amount to commission members in order to buy their licenses.

     In this case, the receivers of the monopoly rent are the members of the commission. The auction money is distributed among them. Accordingly, we might expect rent seeking to occur among prospective commission members before they are appointed. Suppose, for example, that the city council appoints commission members according to a majority vote. The council takes a poll among its members and the candidates for the commission who receive the most votes win. Then someone who wanted to become a commission member in order to earn auction money from bidders for taxi licenses would be willing to contribute to council members' political campaigns or to pay them bribes. If there was intense competition among prospective commission members, they would be willing, in sum, to invest resources slightly less than the capitalized value of the monopoly rent they expected to be transferred to them by taxi drivers.

     As we said, a sensible city council would not permit commission members to auction licenses and to keep the money. However, due partly to the rational ignorance of voters, it might naively fail to recognize that commission members have an incentive to take bribes from prospective taxi licensees. To try to avoid this problem, the city council could make it illegal for councilors to take such bribes. Because of the high prospective gains, however, an anti-bribery law would have to be vigorously enforced. The enforcement cost is another type of rent seeking loss.

     This analysis helps us understand why legislators and appointed bureaucrats may favor certain laws. Suppose that there is no limit on the number of taxi licenses and that licenses are freely given to anyone who meets the minimum qualifications. Suppose further that the city council is considering passage of a law that restricts the number of licenses. It plans to create a commission to allocate licenses. Finally, suppose that you know that you will be a commissioner who can receive taxi-drivers' bribes. Then you would probably favor such a law because you expect to be the recipient of monopoly rent. Taxi drivers who might expect to receive licenses without having to pay the maximum license fee may also favor such a law. So would politicians who expect to be the recipients of campaign contributions or bribes. The extent of these incentives depends not only on the size of an individual's expected rent but also on how much a person expects to invest in her rent seeking activities.

Politicians as Rent Seekers

     To see how politicians may be rent seekers, assume that members of the collective allow politicians to keep any money they receive in exchange for appointing commissioners. Then we would expect the politicians elected to the city council to auction off the rights to be commission members. In this event taxi drivers would charge nearly the monopoly rent price, commission members would auction off taxi licenses at nearly the monopoly rent price, and politicians would charge nearly the monopoly rent price to individuals who want to become commission members. As rent seekers, the candidates for city council posts would invest heavily in political campaigning in an attempt to get elected so that they could partake in the monopoly rent. Sensible and informed voters would not allow a city council to earn money by selling rights to become commission members. However, the exercise serves to warn us about the potential profits from bribery and corruption on the part of politicians.

Recipients of Services and Taxpayer Groups as Rent Seekers

     Finally, suppose that taxi drivers, commission members, and politicians are all unable to divert the revenue from taxi licenses to their own pockets. The money collected from the auction of taxi licenses must be turned over to the government budget office. Then there may be rent seeking by taxpayer groups or recipients of services.

     To see how a taxpayer group may be a rent seeker, imagine that the city council has decided to use the money collected from the auctions of taxi licenses to reduce taxes but that it has not yet decided how. Then competing groups of taxpayers may invest resources to persuade council members to decide on a plan that reduces taxes to their group. For example, one group may favor increasing tax exemptions to the lower income households, another group may favor exempting interest or capital gains, another group may want to reduce the property tax, while still another group may want to reduce the sales tax.

     To see how recipients of services might become rent seekers, imagine that the license fee money is earmarked for building additional public parks, as we did before. Assume further that the city council has not yet decided where the new parks will be located. Then competing community groups may invest resources in order to persuade city council members to vote for a park in their community.

     With so much rent seeking, the waste from transactions (i.e., the transactions costs) would be quite high. It would be difficult to conceal all this from voters. Being sensible people, voters would not permit it. Again, however, the exercise serves to help us understand the different types and levels of complexity of rent seeking.

3. A MORE COMPLEX EXAMPLE

     The reality of monopoly rent seeking varies from case to case. Once we understand the theory, the best way to proceed is to examine a number of specific cases. Specific cases can be very complex. Although we only have space here to consider one, our study should give us an idea of how to apply the theory to other cases.

     Consider a chemical company in the U.S. that wants protection against foreign competitors. To determine how to best achieve its goal, it hires a lobbyist. The lobbyist proceeds to visit several legislators in order to determine their opinions. Then he reports back to the chemical company that he is unable to obtain the necessary votes because some legislators refuse to vote in favor of the bill. They do not see how their constituencies can gain. Moreover, they are afraid that if they vote for the bill, they may lose votes in the next election partly because a strong environmental lobby opposes the bill. Upon hearing the report, the company CEO and lobbyist sit down to discuss their options.

     During the discussion, the chemical company's CEO reveals that she wants to build three new factories in the near future and that she is planning to build them in three different low-wage states. Her goal is to take advantage of the lower costs of production. The lobbyist responds, that the representatives from two of the low-wage states could never be persuaded to vote for the protectionist bill and that the representative of the third is already committed to the bill. "However," he goes on, "if I could promise three opposing legislators that you would build a chemical factory in their states, I believe that I could get the necessary majority to support the bill." So the CEO agrees to the plan, the promises are made, and the bill is passed.

     In this example the chemical company is a rent seeker. The legislators may also be rent seekers. We have assumed that they receive no money from the chemical company. However, if the company's decision to build the new factories helps them get reelected, they may be able to obtain other rents due to their political power. They may also receive bribes or favors from local builders or other beneficiaries of the chemical company's plan.

     Ordinary citizens in the legislators' states are the passive beneficiaries of the plan. We would not ordinarily regard them as rent seekers. However, we can imagine a situation in which they would become rent seekers also. Suppose that a unionized factory had previously closed down, resulting in many unemployed workers. In order to help them, the union representatives may decide to lobby the legislator. The union wants her to approve the protection for the chemical company against foreign competition if the company agrees to establish factories in the place where the union is located. The union (that is, its members) would in this case be a rent seeker. Its rent comes at the expense of (1) the workers in the lower-wage states, which the chemical company would otherwise have chosen, and (2) the consumers of the now higher-priced products that require the chemicals in their production processes. The important point to economists is that the procedure results in waste. Instead of using the method of production that the company executives believe is most cost efficient from an economic standpoint, the company uses a method that is most cost efficient from a political standpoint. The result is an efficiency loss in the chemical industry. In addition, Public Choice points out that there is an investment loss due to lobbying and that there are other possible costs due to enforcement and defensive rent seeking.

     We should not conclude from the examples in this chapter that all lobbying leads to inefficiency. In the first place, we have already noted that even though a project is adopted as a result of lobbying, people may regard its benefits as greater than its costs. In the second place, lobbying can perform the function of informing politicians about voter demands. Having learned about these demands, a politician may be in a better position to choose the output of some public good that is preferred by a majority. Although one of the reasons why rent seeking may be wasteful is lobbying, lobbying may be carried out for reasons other than the seeking of rent.

4. REDISTRIBUTION RENT SEEKING

     The purest form of redistribution is a transfer of money from one person or group to another. Imagine that the people in one group feel that they deserve some of the money that would otherwise belong to the people in another group. An example is that of aborigines who believe that they deserve some of the money income received by wealthy people who are occupying the land of their ancestors, which was appropriated after a bloody aggression. Another example is that of distinguishable minority groups, such as blacks or women, who believe that they deserve money to compensate them for discrimination against their ancestors or for alleged biases in the inherited institutions and culture.

     Besides money, redistributions may consist of transfers of rights to use resources. Democratic legislatures in the early U.S. and Australian democracies passed laws that allocated the land occupied by aborigines to the European immigrants. It gave the immigrants the right to use the land by allowing them to call on the military and police to expel the native peoples. Similarly, several democratic state legislatures in the early U. S. passed laws that treated black slaves as property. It thereby transferred the right to command the work and the initial right to the product produced by the work from black people to the whites who owned them.

     The European immigrants, the aborigines, blacks, women, and similar groups have often formed pressure and invested large amounts of time and money for the purpose of obtaining redistributions of money and other rights. In modern times, such redistribution rent-seeking groups often face strong defensive investment from those who who stand to lose.

     When laws are passed that redistribute wealth from one group to another, there is no efficiency loss from rent seeking. There are, however, investment costs since the prospective gainers and the prospective losers have incentives to influence legislators. To the extent that the investments lead to the diversion of resources from the market economy, these are also investment losses. In addition, there are costs of administering and enforcing the redistribution after it occurs. These are typically the costs associated with collecting the additional taxes needed to transfer the money, property, or rights; and the costs of distributing it to the beneficiaries.

     One type of cost associated with redistribution is often overlooked. We can call this an eligibility cost. A law that causes a redistribution of wealth must also tell the characteristics of individuals that make them eligible to receive the items that are redistributed. In other words, it must specify eligibility requirements for recipients. Because individuals can change their characteristics, they can also change their eligibility. For example, a plan to compensate aborigines may lead mixed race individuals to incur costs in order to prove that they are eligible to be classified as aborigines so that they can receive a share of the compensation. If an individual uses resources or sacrifices satisfaction that he otherwise could have had in order to achieve eligibility, her cost is also a loss due to rent seeking. Prospective recipients of

government compensation during periods of unemployment often give up opportunities to get jobs in order to maintain their eligibility to receive the compensation.

     We have said that trying to pass a law in order to cause a redistribution does not entail an efficiency loss. Because of this, our decision to classify such an action as rent seeking may seem questionable. The justification is that the actions are very similar to those performed by rent-seekers.

     In order to get an idea of the many forms that redistribution rent seeking can take, let us consider some additional examples. (1) Low-income taxpayers may join together to shift part of the tax burden to high-income taxpayers. (2) Consumers of one local public good may join together to persuade legislators to shift spending from a different local public good even though it is not more efficient to do so. (3) Members of a government employees' union may strike in an effort to obtain higher pay or benefits. (4) Legislators may pass laws to increase their own pay or privileges or to give incumbents a greater advantage over challengers even though it is not in the interests of the collective for this to happen. (5) Employees of a government bureaucracy may join together to persuade legislators to increase the size of their bureau beyond the efficient size. (6) A bureau chief may exaggerate or distort the bureau's costs or the demands for its services in order to raise the size of the bureau beyond its efficient size. (7) Suppliers of public goods by contract may contribute to a legislator's campaign in order to win her support for continued or increased funding, even though more funding is inefficient. In each example, individuals try to cause laws to be passed in order to get money or other benefits that would otherwise go to someone else. In doing so, they invest their time and/or resources and thus cause an investment loss.

Questions for Chapter 16

1.  Define rent seeking, monopoly rent, rent seeking investment cost, defensive rent seeking, net rent seeking loss, eligibility cost.

2.  Rent seeking is defined as a legal act. How then can paying a legislator to vote for a law be a method of rent seeking.

3.  Under what circumstances does monopoly make a positive contribution to the wealth of a society?

4.  Tell why a monopoly buyout ordinarily brings only short term profits unless the monopolist receives a helping hand from government. Demonstrate by using an example that is different from the one in the text.

5.  Suppose that a previously competitive market is monopolized, say by means of a monopoly buyout. Explain how consumers would be affected. (Hint: it would be wise to divide the post-monopoly consumers into two classes.)

6.  The text uses the term "monopoly price." Is it possible for a monopoly price, and therefore monopoly rent, to exist when there are several competing firms in an industry? Explain.

7.  Suppose that a previously competitive market is monopolized, say by means of a monopoly buyout. Under ordinary conditions, there would be an efficiency, or deadweight, loss. Describe this loss.

8.  Tell the difference between the efficiency loss and the investment loss due to rent seeking. It may help to use an example.

9.  Suppose that a competitor achieves a monopoly position by persuading legislators to grant him a special monopoly privilege. He accomplishes this by hiring campaign workers to help legislators get elected. Identify the losses, or wastes, due to this kind of rent seeking. In other words, tell how to calculate the net rent seeking loss.

10.   Suppose that a competitor achieves a monopoly position by bribing the police chief to prevent competitors from opening a business. Identify the losses, or wastes, due to this kind of rent seeking. In other words, tell how to calculate the net rent seeking loss.

11.   Considering the cases in questions #9 and #10, tell the difference between the net rent seeking loss in the two cases.

12.   Identify the five components of the net rent seeking loss described in the text. In other words, tell how to calculate the rent seeking loss.

13.   Is it possible that resources would be wasted in rent seeking even though no monopoly is ever achieved? Explain.

14.   Could the dollar value of resources spent to achieve a monopoly position through rent seeking ever exceed the dollar value to the monopolist who is granted the monopoly? Explain.

15.   In the example of the rice tariff, describe the groups that might be involved in rent seeking (i.e., the groups that might seek rents. In other words, tell who might benefit from trying to influence legislators to pass or not to pass a tariff bill.

16.   In the example of the rice tariff, assume that all of the potential rent seekers form pressure groups in order to influence legislation. Opponents also join pressure groups in order to prevent the rice tariff from being passed. However, a small tariff bill is passed anyway. Identify the various parts of the net rent seeking loss and classify them according to whether they are efficiency losses or investment losses.

17.   Using an example that is different from the text, show how members of a city council may become rent seekers.

18.   In the more complex examples of taxi drivers as rent seekers, the restrictions on taxi licensing caused taxi prices to be higher than otherwise. Yet the taxi drivers ultimately earned no monopoly rent. Explain this apparent contradiction.

19.   Find an example of what you believe to be rent seeking in your community. Describe the individuals or groups who actually receive the rent, describe their rent seeking activities, identify those who are harmed by the rent seeking, and why the harmed individuals did not succeed in stopping the rent seeking.

20.   Identify the sources of rent seeking loss in the case of redistributional rent seeking.

21.   Tell how rent seeking for monopoly privilege differs from redistributional rent seeking.

22.   Explain the eligibility cost associated with redistributional rent seeking.

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Feng Chia University
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