The Problem of Rent-Seeking and Corruption

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Though rent-seeking is often associated with autocratic or particularly corrupt governments, rent-seeking behavior occurs in any society where industries or interest groups boost their surpluses through government favors. Rent-seeking is especially problematic in developing economies because it is believed to limit long-term economic growth and increase the transaction costs of doing business in society. An analysis of the economic costs of rent-seeking reveals that the inefficiencies created by these practices arm harmful for both governments and the economy as a whole.

Rent-seeking refers to economic favors granted by the government that entrench the standing of industries or organizations in the economy. Further, the term “rent” denotes the receipt of profits or economic rewards that exceed the opportunity cost of doing business (Lecture 12 and 13 7). Essentially, economic actors seek rent when they collaborate with the government to obtain excess profits by increasing their share of the surplus produced. Governments can secure rents or aid industry and businesses in seeking rent by enacting laws, fees, and regulations that restrict market entry to competing firms (7; 16). While rent-seeking is not necessarily corrupt on face value, practices associated with rent-seeking, such as distributing permits to limit market entry, can become a source of government corruption (16). In order to objectively assess rent-seeking practices in all governments, the World Bank’s “Doing Business Report” attempts to identify which countries are most corrupt. However, because rent-seeking governments often conceal their activities and alter data (17), it can be difficult to properly interpret distorted data from corrupt governments. Further, the subjective nature of rent-seeking makes it difficult to determine whether particular practices are truly corrupt or simply a valid institutional function.

As critics of corrupt rent-seeking practices highlight, rent-seeking undermines the long-term growth of the economy. The first implication of rent-seeking is that it alters the economic institutions under which an economy operates. Daron Acemoglu, Simon Johnson, and James A. Robinson define institutions as “rules of the game in a society” (Acemoglu, Johnson, and Robinson 388). Specifically, economic institutions include features of an economy that contribute to these rules, such as the structure of property rights laws and the structure of the markets (389). As Acemoglu et al. assert, the economic institutions that a society possesses serve as the fundamental explanation for economic growth or dilapidation (397). For example, by 2000 South Korea’s per capita income was $1600 while North Korea’s per capita income was $1000 (406). While the two countries share the same culture and North Korea possesses an advantage through its possession of natural resources and capital gained from the Japanese during World War II, the socialist economic institutions hindered the development of the North Korean economy (406). Rent-seeking also presents institutional changes that adversely impact the characteristics of an economy.

The first significant institutional impact of rent-seeking is that it creates conditions that undermine property rights. Rent-seeking governments are characterized by their ability to siphon large portions of wealth from the overall economy through fiscal means while utilizing their political authority to violate the property rights of private individuals or business entities (Lecture 12 and 13 13). Yet, the security of property rights plays a fundamental role in economic development. As Mancur Olsen asserts:

“We know that an economy will generate its maximum income only if there is a high rate of investment and that much of the return on long-term investments is received long after the investment is made.” (Olsen 124).

Yet, as Olsen notes, autocrats often think with the short term in mind when they utilize their power to confiscate and redistribute resources from the private economy (125). Further, the instability that is caused when property rights are not secure results in wider cases of capital flight (128). Thus, from a theoretical standpoint, rent-seeking is posited to hinder investment in the economy.

The contention that rent-seeking stagnates economic growth can also be established through empirical research. In their research on the English Glorious Revolution of 1688, Douglass C. North and Barry R. Weingast establish a relationship between economic institutional structures and economic growth. Preceding the Glorious Revolution, the monarchy engaged in rent-seeking activities that caused civil unrest (North and Weingast 804). However, the Revolution established a representative government that limited the monarchy’s confiscatory powers while securing property rights and protecting the wealth of private individuals (803; 804). Yet, despite losing the power to confiscate private resources, the government prospered after the reforms were made.

North and Weingast conduct a longitudinal analysis of the capital markets of England to determine the health of the economy before and after the institutional reforms ushered in by the Glorious Revolution were enacted. Through their research, North and Weingast establish that the government’s expenditures in 1697 were four times greater than the year prior to the Revolution (822). Because confidence in the government increased, loans and debt manipulation practices ceased, investors were more willing to loan funds to the English government (805). Further, their analysis of the capital market revealed that the private markets also benefited from increased investments as overall borrowing increased and interest rates decreased (823). An added benefit of this development was that the expansion and availability of capital enabled a wider range of projects to receive funding, which aided in economic diversification (825). As the research reveals, reforming corrupt economic institutions not only benefits the private industry, but it also benefits the government and the general economy.

Along with stunting long-term economic growth, rent-seeking can also impose burdensome transactional costs on the private industry. A case study measuring the growth of European cities 800 years before the Industrial Revolution, Schleifer and Vishney revealed that autocratic systems were likely to enable tax policies that were unfavorable to economic growth (Lecture 12 and 13 11). Further, research determined that rent-seeking led to the misallocation of talent in the government by attracting talented employees to sectors that benefited from government favors (12). The inability to obtain talented labor increases transaction costs for private employers because it is necessary to inflate wages in order to increase with the segments of the economy that benefit from rent-seeking. Thus, as Schleifer and Vishney establish, the economy as a whole is adversely impacted by the inefficiencies that are induced when governments engage in excessive taxation or manipulate the labor market in order to favor select industries.

Though all governments engage in rent-seeking to a certain degree, excessively corrupt practices that hinder the free market in favor of select groups can undermine the long-term growth of the economy. Olsen establishes the theoretical framework for assessing the disincentives that corrupt institutional practices create for private businesses. Further, North and Weingast present empirical research that establishes the connection between government confiscation of resources and lower levels of investment in the economy. Additionally, Shleifer and Vishney reveal how transactional costs through higher taxes serve as a barrier to economic growth in an economy with high incidents of rent-seeking. As these studies reveal, the inefficiencies created through rent-seeking undermine the development of economies by hindering the market conditions that encourage investment and United States economic growth.

Works Cited

Acemoglu, Daron, Siman Johnson, and James A. Robinson. “Institutions as a Fundamental Cause of Long-Run Growth.” Reading in Handbook of Economic Growth, Volume 1A. Eds. Philippe Aghion and Steven N. Durlauf. San Diego: Elsevier. 338-467. Print.

“Lecture 13 and 14.”17 Oct. 2013. Lecture.

North, Douglass C., and Barry R. Weingast. “Constitutions and Commitment: The Evolution of Institutional Governing Public Choice in Seventeenth-Century England.” The Journal of Economic History 49.4 (1989): 803-32. JSTOR. Web. 18 Oct. 2013.

Olson, Mancur. “Dictatorship, Democracy, and Development.” Readings in Democracy, Governance, and Growth. Ed. S. Knack. Ann Arbor: University of Michigan Press, 2003. 115-35. Print.