Dec 17, 2018

The Macroeconomics of Rent-Seeking

A Macro Musings Transcript
David Beckworth Senior Research Fellow , Matthew D. Mitchell Director of the Equity Initiative

While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth: Our guest today is Matt Mitchell. Matt is the director and senior research fellow of the Equity Initiative here at the Mercatus Center. Matt joins us today to discuss rent seeking, and how it affects long-term economic growth and prosperity. Matt welcome to the show.

Matt Mitchell: Thanks so much for having me.

David Beckworth: I'm glad to have you here, I think this show will help tie together some threads, some themes we've had on previous episodes we've had. Brink Lindsey, Steve Teles on before talking about their book The Captured Economy. We touched on some of the issues we'll be touching on today. I've had Jesse Eisinger on the show, he talked about some of the regulatory capture in the finance industry, corporate America, why wasn't anyone prosecuted out of the great recession?

David Beckworth: There's a lot of themes that run through these discussions, and some of the other ones we've had, and this show will tie them together nicely, because you're going to kind really explain what rent seeking is, how it is tied into the broader literature in economics, and ultimately why this matters for economic growth? This is Macro Musings, why do we care about this? Is because it affects long-term economic growth, and that's macroeconomics.

David Beckworth: One of the things we stress in macroeconomics is the importance of productivity to long-term economic growth, and particularly when we get technical, we talk about total factor productivity which is really a residual. But in that we know there's technology, and also institutions, and the quality of institutions is important for long-run economic growth. You want a well-functioning system, trust, and what we're going to touch on today I think is real important and tied to that.

David Beckworth: And I want to begin by kind of asking what I think is the big umbrella phrase for this area of economic literature, public choice economics. So explain to our listeners, what is public choice economics?

Matt Mitchell: Well in a nutshell it's essentially the economics of political decision making. Historians of economic thought will tell you that really when economics began it was about markets and about politics. It's was political economy. And Alfred Marshall's famous textbook, I think it came out 1890, sort of marked the separation of that where economics really became a field in and of itself only looking at markets. And it became political scientists were the ones who studied politics.

Matt Mitchell: And that prevailed for about 50 or 60 years and then in the middle part of the 20th century public choice economics emerged, and in large part that has tried to bring back the economic analysis of politics, sort of bring it back into the fold so that we don't just treat politics as completely exogenous.

David Beckworth: Why is this important to have this field re-emerge?

Matt Mitchell: Well one way to think about it is what was going on in economics in the mid part of the 20th century that brought this about? So in some ways it was a reaction to welfare economics. So you had Pigou's book and then Samuelson, and Francis Bator and others that are developing this idea of welfare economics. Which is essentially, okay we define a perfect market, we even have the term, perfectly competitive market, and then we look for reasons why the market might depart from that blackboard perfection?

Matt Mitchell: And we can come up with all sorts of reasons, there's everything from externalities to monopoly to information problems. And then we recommend public policy to correct it, and sort of the Pigovian tax is a perfect example is, okay you figure out exactly how much cost is exported onto somebody else, and then you impose a tax to try to help externalizers internalize.

David Beckworth: Can you give us a concrete example of a polluter, how would that work?

Matt Mitchell: Yeah, and it's a compelling story I think that both economists and non-economists will understand. So a few years ago, if your fans like spicy food they may have had Sriracha, there was a Sriracha plant in California that opened and people downstream from it, downwind from it I should say, were finding that the backs of their throats were getting itchy.

David Beckworth: Interesting.

Matt Mitchell: And so it's a perfect example of a negative externality, it's imposing costs on others, and so what do you do to try to correct for this? Well Pigou said we impose a tax. Ronald Coase later said there's another way is if transactions costs are low, and that's important, we can't just assume that they're low, but if they are low then you make sure that property rights are clearly defined one way or the other, somebody is liable. And you allow people to trade.

Matt Mitchell: So what public choice does though, is say let's actually look at how the decisions are made in the political setting? Let's not just assume that Professor Pigou tells the policymakers internalize the costs through a tax named after me. We actually see what they do. What are the incentives of policymakers to follow through on that? And in fact, actually one of the central insights of public choice is that in politics there's externalities as well.

Matt Mitchell: And so you have recognize that majorities impose costs on minorities. That active politically organized groups impose costs on minorities in active groups. You have to recognize that current voters impose costs on future voters or non-voters. So once you start to analyze it, essentially on the same analytical grounds, you assume it's the same person who walks into a boardroom, or buys peanut butter is also the same person who walks into a voting booth and selects the president of the United States.

Matt Mitchell: Once you put them on sort of even analytical ground it changes the analysis there.

David Beckworth: Yeah, so the idea if I can summarize it in a nutshell is, the same humans that mess up and cause market failure, and cause problems, who corrupt, who steal, who make us worry about capitalism at times, are the same people who can behave badly in government. They respond to the same incentives, no matter where you are, you want to make yourself better off, if that includes some corruption, so be it. Whether it's the private sector or public sector.

Matt Mitchell: That's right. So James Buchanan who was an early founder of public choice, the way he put it is, it's politics without romance. Now it seems weird actually in some ways to think about politics romantically now because a lot of your listeners will think, who in the world has any romantic views of politics these days? It's dystopian, right?

David Beckworth: Right.

Matt Mitchell: But in the middle part of the 20th century there was an enormous amount of romance about the idea that when you vote, somehow you discover what's right and true, and good. And even today, a lot of people still strangely romanticize politics in the abstract when they start talking about actual politicians, Donald Trump, it gets significantly less romantic.

Matt Mitchell: But people still romanticize the idea, this is embodied in Hillary Clinton's famous statement, that government is that which we do together. Well it's a little bit more than that, and some of it's a little messy, and it's not quite that romantic.

David Beckworth: Yeah and this is a critique, now, again, you're stating that formerly, butthis is a critique that's understood already I think implicitly by people on the left, and the right. So for example, the new Amazon headquarters, the two new headquarters one is here near where we are recording in Northern Virginia, the other one is in New York City. But the one in New York City received a lot of blow back from liberal politicians because of all the money, although you could loosely say bribing, that's going on to land it there. And it was surprising to hear the progressives go after the deal.

David Beckworth: You know that's something you might think that the right would go after, but the left is going after it.

Matt Mitchell: Yeah, that's right. So in a lot of ways public choice is not a left or right discipline, in fact some of the early contributors, Anthony Downs, Mancur Olson are sort of left of center folks, as well as of course there's some right of center economists in James Buchanan and Gordon Tullock who have contributed as well.

Matt Mitchell: But particularly in this area, favoritism, which is my research focus, I think there's a lot of opportunity for the left and the right to come together. I think too many on the left are upset about inequity, and when you really drill down to it, it's not necessarily even inequity that's the cause of the market, but it's inequity that's built into public policy.

Matt Mitchell: And a lot of people on the right, they want less government, and they say that they want pro-market, but many of them confuse being pro-market with being pro-business. And so I think there's a lot of opportunity actually for left and right to come together and say, we may not agree on everything, but equity is actually a very philosophically appealing notion. Equitable treatment.

David Beckworth: Yeah and that's the name of your initiative here, Equity Initiative, working toward that. Now a category underneath this broad umbrella of public choice, and there's a journal called Public Choice, by the way you're going to have a special issue coming out, and we'll talk about that in a minute. That's going to touch on some of these issues, but there's another name or category called rent seeking. So explain to our listeners what is rent seeking, maybe give some concrete examples of it?

Matt Mitchell: Sure, so the idea of rent seeking is the notion that whenever public policy results in a transfer, so for example, it could simply be a tax on David to subsidize Matt, or it could be a regulatory transfer. A policy that creates a barrier to entry that somehow gives David a monopoly. Whenever real resources or economic surpluses transfer, people have an incentive to expend resources seeking, and or opposing that transfer.

Matt Mitchell: Relatively simple idea, but it has pretty profound implications, and strangely enough it's one that economists weren't particularly focused on until Gordon Tullock developed this notion in a 1967 paper. So one application of this would be theft, or fraud, or force. So when I talk to students about this I like to tell the story of what I learned from my daughter's pop-up book. So about five years ago I was sitting reading my three year old a pop-up book about dinosaurs, and in it I learned about the Bone Wars.

Matt Mitchell: So the Bone Wars was this kind of crazy episode in the 19th century where two early paleontologists Othniel Marsh and Edward Cope were sort of racing to out compete one another to find more dinosaur bones. And between the two of them they found about 150 species including all the cool ones, right? Tyrannosaurus rex and others.

Matt Mitchell: But their competition started out pretty helpful, pretty virtuous, when one would make a mistake and put the wrong dinosaurs head on the tail of another dinosaur, they'd correct it. But at some point it turned vicious. So at one point the two teams were digging in Colorado and they threw rocks at one another. And then they started spreading rumors, some true some false, about one another. And then at one point they actually resorted to dynamiting one another's finds, burying or obliterating countless specimens, right?

Matt Mitchell: So I was reading this, and I thought this is a perfect example of rent seeking. So it's the expenditure of wasteful resources in order to try and obtain some kind of contrived exclusivity. Now you can dynamite your competition if you can use fraud or force, but today you don't need to resort to dynamite, you can go to the government and effectively dynamite your competition by asking for some type of regulation that hobbles them, asking for a subsidy whereby taxpayers like you good people in Arlington are coerced into subsidizing Amazon, or some sort of regulatory or tax privilege.

David Beckworth: So let me give an example, and tell me if this is rent seeking. So Facebook has over this past year received a lot more scrutiny because of the fake accounts, the Russian accounts, the bots that have spread fake information. And so Mark Zuckerberg came to Congress, and he said give me some regulations, help me out here. And that seems noble, and a great gesture on the surface, but the public choice cynic might say, what he's really saying is give me regulation that only I, Facebook, have the resources to handle, and that will snuff out any kind of other social media innovator.

David Beckworth: So if there's another potential competitor out there, they won't enter the market because there's these huge barriers to entry created by new regulations that only Facebook can keep. So is that an example of rent seeking?

Matt Mitchell: Yeah it is. And I think a good rule of thumb is, if a business is asking to be regulated, they're probably rent seeking. But one of my favorite examples here, is a few years ago, it only lasted a few years, but there was a ban on incandescent light bulbs. And NPR did a story where they said, what's this all about, why is there this ban on incandescent light bulbs? Let's interview people who make light bulbs and see do they like it?

Matt Mitchell: And Peter Overby did the story, and he interviewed people everywhere from manufacturer's and engineers at GE all the way down to people who sell them on the floor of Home Depot. And to a person they all said we like the ban, it's fine. And one of the people at GE said yeah we actually have a lobbyist go down to Capitol Hill and he explains why it's just as easy to make the new kind of compact fluorescent light bulbs as it is to make the old incandescent. And so he kind of just wraps up the story there.

Matt Mitchell: But around this time, an economist who has studied rent seeking is probably yelling into the radio saying, “wait a second. You talked to a guy who said he employed a lobbyist? Who asked for a restriction on himself?” Lobbyists are not cheap, these are expensive guys, right? Why, you can make the old kind of light bulb, nobody's telling you you can't. You can make the new kind of light bulb on your own if you want, why would you ask for a restriction that says you can't make the old kind?

Matt Mitchell: Well the reason is GE has a comparative advantage in making compact fluorescent light bulbs. They're one of the only companies in the world that can do them as cost effectively as they could back then. But anybody could make an old incandescent light bulb, so that when they were asking for a ban on the old incandescent light bulb, it was a ban that raises their rivals’ costs. It was a regulation that imposes costs on people who can easily compete with them, allowing them to capture the market on the margin of the type of light bulb that only they can make well.

David Beckworth: So it's a wasteful endeavor where GE and other firms are actually spending resources to have this privilege. And maybe if we speak to the term itself, rent seeking. So what is an economic rent, and then how does it become rent seeking?

Matt Mitchell: So this I think is one of the tragedies of the field, is it's got this weird name. So I would argue rent seeking is one of the more interesting, and important advances in economic theory in the 20th century. But I think this name has contributed in some ways to it not being a very accessible, or understandable idea. So we can blame David Ricardo for this in part.

Matt Mitchell: So David Ricardo in the 19th century I think it was around 1820 was writing about rents on land. And essentially, because of him the profits that you could make from being an exclusive producer, or having an owner of an exclusive asset came to be known as rent. So if you want to think about it just in modern terms, we can just say rent is monopoly profits okay?

Matt Mitchell: And so being exclusive, that can be natural. So Michael Jordan, LeBron James they have exclusive talents, and so a good portion of their earnings are rent. But rents can also come about by being sort of a first mover. Apple was one of the first to have a mass produced smartphone, and so a lot of what they were earning in those early years of the smartphone business were rents. All of those sort of natural rents they're not necessarily problematic. Where you have problems is when that exclusivity is contrived, where you use fraud or force in order to obtain that exclusivity.

Matt Mitchell: So how do you do that? Well in the private market you can do it through fraud or force like Othniel Marsh and Edward Cope throwing rocks at one another, and dynamiting one another's finds. In an office setting, if you spread rumors about colleagues, or try to control information flows, there can be rent seeking within a firm. But where a lot of the literature focuses is on using government to try to contrive that exclusivity. And so it's using that institution which has a monopoly on legitimate use of force as Max Weber tells us, is the definition of government.

Matt Mitchell: You can use government to impose a regulation or tax, or a subsidy and contrive exclusivity, and through that obtain monopoly rents.

David Beckworth: Okay so rent seeking is this extra profit, extra monopoly profit above a basic income that would go to the resource, and some of it occurs naturally if you're a super talented individual, you have an exclusive skill set like these basketball players. But some of it's contrived. And so I just wanted to highlight a couple of Nobel laureate economists who have mentioned it, and I'm going to mention two, Joe Stiglitz, I was just preparing for this show. He has invoked it quite a bit, in 2012 he had a piece where he wrote that most of what goes on in the financial sector is rent seeking. And he goes off, of course this is after the Great Recession, and the critique was, anyone in the financial sector, they tend to, all the gains are privatized, you keep all the gains, all the losses are socialized, and you find ways for the government to bear the risk.

David Beckworth: And so from his view that there's a bunch of rent seeking going on, a more recent piece, last year by Angus Deaton, he makes this claim. He says, rent seekers are destroying capitalism not income equality. And he goes on to say two big sectors, banking during the financial crisis, and he also points to healthcare as two prime examples where we see lots of rent seeking. And he goes on to say, a point he makes is there's a lot of smart people, and resources that are dedicated to maintaining the monopoly profits, the added value that these industries are getting.

David Beckworth: So people who might otherwise be employed in more productive endeavors, finding a cure for cancer, for AIDS, whatever it may be. They spend their time trying to protect the industries. How pervasive is this, and should we care? This is an interesting observation, but is it hugely consequential to our growth, or our standard of living?

Matt Mitchell: I'd argue it's very consequential. But one of the sort of paradoxes and difficult things with it, is it's extremely elusive in terms of trying to measure it. Trying to get a handle on it. Because it's quite subtle, so let's go back to Gordon Tullock's famous article, 1967 in which he first identifies this problem. It's called "The Welfare Costs of Terrorist Monopolies and Theft" and theft is on there actually an editor suggested that he add that to the title because that's a big section in the paper.

Matt Mitchell: And he illustrates the problem by thinking about the transfer of theft. Now strangely enough before this article, economists tended not to think of theft as socially costly.

David Beckworth: Huh.

Matt Mitchell: And the reason is if Matt takes from David, David loses but Matt gains, and my gains are exactly offset by your losses. And so when economists were talking about the problems of monopoly, yes they had identified a dead weight loss, sometimes called the Harberger Triangle after Arnold Harberger.

David Beckworth: Explain to the listeners who don't know what a dead weight loss is.

Matt Mitchell: Yeah so this is basically the idea that any time you have a monopoly, the monopolist gains, but it's at the expense of consumers and would be competitors. Your listeners can't see this but I put expense in quotes because it doesn't actually mean that we take from consumers, it just means that consumers, and would be competitors don't gain as much from the exchange as they might if it were a communitive market. Okay?

Matt Mitchell: And so the idea is that the gains from the monopolist actually are not as large as these "losses" from consumers and would be competitors. And Arnold Harberger in the mid part of the 20th century was doing some calculations and tried to estimate this loss, and he kind of said you know it's actually pretty modest. So what Tullock comes along and points out is, well actually how do firms get monopolies? Every so often you can find a story of a firm that just naturally happens to possess a natural resource or something like that. De Beers and diamonds is a commonly cited example.

Matt Mitchell: But nine times out of ten, the real source of monopoly power is some sort of government grant of a monopoly. A regulatory privilege, a regulatory transfer, special taxes, subsidies or something like that. And so his reasoning is firms actually expended a lot of resources trying to obtain that privilege. Now here's the part that's kind of weird, is if the firm say just bribes the king or the queen in order to get the monopoly that actually still isn't necessarily rent seeking. That's just a transfer, and it's a transfer to the king or the queen.

Matt Mitchell: The real source of rent seeking loss is if the firm does something that is inefficient in order to obtain it. So the firm for military contractors, there's stories of tanks being assembled in 218 different locations around the country in order to assemble, not because that's the efficient way to assemble the tank, but because that's the politically efficient way to assemble the votes, right?

David Beckworth: Okay.

Matt Mitchell: Or another example would be in order to obtain the 3.5 billion dollars from the state of Wisconsin, Foxconn had to promise to hire, I think it was 3,000 employees, and make some 10 billion dollars in investment. Now from Scott Walker's perspective, oh that's a great thing, right? Because we got them to hire people and to make an investment. But an economist would say no, those are costs, those go on the cost side of the ledger. Nobody would ever go to a private investor and say, hey I've got a great deal for you, I'm going to start this business, and guess what I'm going to employ 3,000 people. The investor would say, I don't care how many people you're going to employ, tell me what the business model is? Tell me what the revenue generating potential of this is?

Matt Mitchell: I don't want to know what the costs are, if anything I want to minimize those costs. So in hiring 3,000 people in Wisconsin, may or may not be the right business choice, but if they are doing some of that not because it's the right business choice but in order to obtain the subsidy, that is rent seeking. But how do you measure that? That's very, very difficult. So I would argue, and this has had a big influence on development economics, Daren Acemoglu and James Robinson have an entire book on this, Why Nations Fail, that's really focused on rent extracting societies.

Matt Mitchell: And they pin a lot of the reason for why societies fail to take off on the problem of rent seeking, and rent extraction, but it's very difficult to measure.

David Beckworth: Now didn't Anne Krueger also contribute to this literature on rent seeking?

Matt Mitchell: Yeah so Tullock had this article, he published his article in 1967 and he took it, by the way, it was rejected a few times. And ultimately went into the Western Economic Journal, not a top journal at the time. And essentially it was ignored. So then seven years later, 1974 Anne Kreuger writes a piece that gets in the AER, I think it's called "The Economics of the Rent Seeking Society", something like that. And it's from her that we actually get the name rent seeking.

Matt Mitchell: And she's a very intellectually honest person, nobody thinks she stole the idea from Tullock or anything like that, she just was simply unaware of it.

David Beckworth: Oh she didn't cite Tullock?

Matt Mitchell: No she didn't cite Tullock, and she didn't know about it. But once it was pointed out to her that she had been scooped, yes she certainly gave credit where credit was due. And so that's actually where we get the term. And then a big, really it took about ten or fifteen years before the article started to take off. A big aid was there was a book organized by Robert Tollison that came out in 1980 that really developed the idea of rent seeking, and from then it started to take off, and now you can do a Google scholar search for the term rent seeking, and you find some 190,000 hits. It's a huge, huge topic in economics.

David Beckworth: And again your sense is, and the literature sense is this is a big deal?

Matt Mitchell: Yeah, but there's really been I think a lot of interesting takes on it since then. So one going back to the initial idea of rent seeking is it's really you can think of it as a static loss. So kind of like dead weight losses, at any given point in time the economy is smaller because people are spending resources seeking rent.

Matt Mitchell: William Bamal in 1990, I think has a really interesting extension on this called, he terms it "unproductive entrepreneurship" and this is the idea that smart, creative, people will change the way they allocate their talents in a rent seeking society. So instead of coming up with new and different ways to develop products, and services at lower cost and greater value for consumers, they’re spending new and different ways to obtain favors or privileges from government.

Matt Mitchell: And so if you think about the implications of this is unproductive entrepreneurship is not just about a loss at any point in time. But that actually changes the growth trajectory of an economy. And Murphy, Schleifer, and Vishny have a paper around the same time that sort of makes the same argument, it's sometimes called "The Effect of Lawyers" research. That basically does some back of the envelope regressions looking at growth and says that societies that have more lawyers, not because lawyers are all rent seekers, but because they may be a good indicator of rent seeking.

Matt Mitchell: You often need a lawyer if you're going to be trying to do some rent seeking. That is a good indication of it, and they find that it has a statistically significant effect on growth. And so as the research has developed we sort of discovered these other kind of avenues, and margins along which rent seeking has an effect. It's not just a static effect, it's a growth effect.

Matt Mitchell: And by the way, it's not just rent seeking, but it's also rent extraction which is a slightly different idea.

David Beckworth: So let me give an extreme example which I think would fall under this, but I want to double check with you. But rise of patent trolls. So these are people who file patents, lawyers, organizations, and they're extracting privileges from government, they'll sue other individuals who make a good, develop a product that is similar to what they've filed in patent. Would this fall under the rent seeking?

Matt Mitchell: Yeah it would, it's an artificially contrived exclusivity. It's almost by definition rent seeking. I think another example in intellectual property is what's sometimes called the Mickey Mouse Protection Act. This is a bill, I think it was Mary Bono sponsored it when she was in Congress, but essentially the copyright on Mickey Mouse was about to expire, and they re-wrote copyright law to say that the copyright goes to the artist for their lifetime plus 40 years. So Walt Disney had already been dead many decades at this point, he didn't need any further inducement to create Mickey Mouse, and ironically it sort of shows the problem.

Matt Mitchell: Because a lot of the ways that Disney became wealthy is using ideas that were in the public domain. Snow White, and Rapunzel these stories have been around for centuries, and it's probably quite efficient for them to be able to use those. But it's a good example of sort of the overzealous protection of intellectual property.

David Beckworth: And resources were used to get that privilege, I guess.

Matt Mitchell: That's right.

David Beckworth: That's what makes this rent seeking. One of the questions this raises in my mind is why did this come up when it did? Why Tullock write about it when he did? And I wonder if there's any relationship between the rise of the administrative state, so as more and more laws are determined by regulatory bodies, if it gives rise to more lobbying, more rent seeking. Is there any kind of correlation there?

Matt Mitchell: One kind of interesting biographical note on Tullock himself is that he had spent a bit of time in the government.

David Beckworth: Okay.

Matt Mitchell: For one he was in the military, he was I think in the beaches of Normandy about 13 days after D-Day, but then later he was a civil servant in the State Department, and so he had sort of witnessed waste first-hand. And one of the things that he had witnessed was people and bureaucrats sort of purposely sabotaging themselves and their agencies in order to obtain transfers. So he would see examples, in his travels in China, he would see examples of local bureaucrats destroying roads that they were overseeing in order to capture a larger road budget.

David Beckworth: Okay.

Matt Mitchell: And you know he said he saw similar things in even Blacksburg, Virginia so I think that's as the administrative state was growing, and Tullock himself had sort of had a front row seat to this, I think that did have a big impact on his thinking.

David Beckworth: Okay. One of the critiques I've seen applied to public choice, and rent seeking is it can make one fatalistic. Like we are so in trouble, humans they screw up the market place, they screw up politics, do we just kind of give up and go home? What does this mean from policy-wise, are we doomed to failure?

Matt Mitchell: I don't think so. Matt Iglesias had a piece around the time that James Buchanan passed away that was quite critical, and made essentially an argument along these lines. That basically if you just say that nothing's going to work, don't you even encourage bad behavior? If you say politics is broken, doesn't it just encourage politicians to be broken, right?

David Beckworth: Right that would be the critique.

Matt Mitchell: And I would say, well let's go back to where this came from, and go back to the beginning of our discussion on externalities. Nobody would ever look at a polluter and say, okay the solution here is to just say that the polluter is a bad person, and to ask them pretty please to stop doing it, right? Most economists say well let's think about the incentives. Let's either follow Pigou and impose a negative externality tax, or let's follow Coase and examine the transactions costs, and see if there's a way that we can use the definition of liability or the definition of property rights in order to get these people to internalize their externalities.

Matt Mitchell: But let's think through the incentives and change it. I would argue that really that is the ultimate recommendation of public choice. When you see externalities in politics, the solution isn't to say just throw the bad guys out, and vote in the new guys and hope that they're better than the old guys. The new boss is the same as the old boss typically.

Matt Mitchell: And so instead, the solution is let's change the institutions of public policy. And this really was James Buchanan's insight after sort of launching the public choice subfield, he launched another subfield called Constitutional Political Economy, and it's all about how can you constrain government through certain devices?

Matt Mitchell: And in many ways, the U.S. Constitution is a good example of this. We don't just say, pretty please Congress don't invade people's rights to free speech, we actually have a constitutional amendment, the first one that says, Congress shall make no law respecting the establishment of religion, and interfering with people's ability to have free speech and to assemble.

Matt Mitchell: So I don't think it's fatalistic, I think that it gives us insight into how we can better design incentives.

David Beckworth: So instead of it being fatalistic, it can be the impetus for better policy for ways to think about, it helps us be aware of the problem and the focus that there is a problem, externalities and politics. You are editing a special issue of Public Choice Journal on this topic. So tell us about that special issue, and what are some of the topics specifically that will be in it?

Matt Mitchell: Yeah, so this was something that I approached the editors of Public Choice about doing with the 50th anniversary of Gordon Tullock's article in mind. And so it should be coming out in the next few months, and it's celebrating that insight. But it's got contributions really across the board, and I think it sort of shows the breadth and depth of Tullock's article.

Matt Mitchell: So we have papers by awesome Acemoglu and Robinson exploring the how rent seeking and rent extraction are relevant to their view of how societies fail or take off. We also have another article that's co-authored by Barry Weingast and a couple of experts on antiquities, exploring their perspective on how essentially the creation of rent can help organize and control violence in a strange way.

Matt Mitchell: So they're talking about sort of the development from a different perspective. But we have other articles talking about rent seeking as it's taught in the classroom, extending the idea of rent seeking and rent extraction. I have an article that highlights really the difference between wasteful rent seeking and other ways to obtain privileges that are not so wasteful, but are inequitable and might offend us philosophically.

David Beckworth: Is this the “Bizarro Market Paper”?

Matt Mitchell: Yeah well the “Bizarro Market Paper” actually is the one that summarizes all the pieces. I have a paper called "Uncontestable Favoritism", and the basic idea here is okay, let's say that I'm a mayor and I'm going hand out a privilege. I could just say hey, go ahead and ingratiate yourself to me, and this would set off a very inefficient rent seeking contest in which people spend lots of time, money, and effort trying to figure out ways to please me, and create value for me and I'll just hand it to the highest bidder essentially.

Matt Mitchell: So that's essentially the definition of a competitive rent seeking market. That's why it's Bizarro by the way, is in a rent seeking market the more competitors you have, the more wasteful it is.

David Beckworth: Interesting.

Matt Mitchell: Whereas if you just give it to one person, it's not so wasteful.

David Beckworth: So 20 firms are wasting resources trying to get that scarce resource.

Matt Mitchell: Exactly.

David Beckworth: Okay.

Matt Mitchell: But I could also just hand it out arbitrarily. Maybe I'm sexist and I hand it out to a man, or maybe I'm racist and hand it out to my tribe, or person from my race. Or maybe I'm happy with nepotism and I give it to my brother in law. Ironically those types of arbitrary favors can be less wasteful because if you know that I'm just going to give it to my brother in law, you won't spend any effort ingratiating yourself to me, right?

Matt Mitchell: So but in that case, still we should care about it, right?

David Beckworth: Right.

Matt Mitchell: Even though it's not socially wasteful.

David Beckworth: That brother in law might be very incompetent with-

Matt Mitchell: Well there is that concern too yes, the brother in law might be incompetent, so there's other ways that are associated with it. But the other thing is, let's say that he's just as competent as the next guy, we still would find that pretty offensive.

David Beckworth: Right.

Matt Mitchell: And waste isn't the only thing we should care about. And so one of the points I'm trying to make in this article is that there's all sorts of ways that favor can be handed out, or disfavor can be handed out. And unfortunately we have this trade-off between really extraordinarily wasteful, but at least equitable favor and disfavor on the one hand. And inequitable favor and disfavor that may not be as wasteful. And so the bottom line is, equity is the way to avoid all of this is by not singling out particular firms, industries, or occupations for favor or disfavor.

David Beckworth: Okay. Now how big is this topic in the literature, rent seeking? Is it something that's widely used? I mean we've touched just a little bit but you've-

Matt Mitchell: Yes, it is. So Anne Krueger's article is among the top 20, has been identified as one of the top 20 articles in AER in the 20th century. The topic of rent seeking, there was a nice anthology put out by Roger Congleton, Kai Conrad, and Arye Hillman that came out I think it was 2008, it's called 40 Years of Rent Seeking and they look at some 300 articles.

Matt Mitchell: I mentioned earlier you can do a Google scholar search and you'll find some 190,000 hits for the idea. And it's had an influence in development economics, and trade, and of course a big part of public choice is focused on it. What I would say though, is it's not, at least from my view, it's not a term that's broken out into the mainstream. Every so often, I'm surprised, you'll find somebody who will like-

David Beckworth: Joe Stiglitz.

Matt Mitchell: That's right.

David Beckworth: Use it.

Matt Mitchell: George Will had-

David Beckworth: Oh a non-economist.

Matt Mitchell: Yeah a non-economist somebody like George Will will have a column where they use the term without necessarily defining it. And so unlike comparative vantage, or monopoly costs, I don't think it's really broken out. But I would argue we're sitting here in Washington D.C., Amazon HQ2 has just been announced, Donald Trump's in the White House. This is a time where rent seeking should be on everybody's mind.

David Beckworth: Yeah it's interesting some of the developments we've seen. I've had some guests on the show who've talked about some trade issues because trade's become a big deal with the current administration. And one of the things that the current administration has done is imposed these steel and aluminum tariffs, but they give waivers, they have these waivers, these exemptions that if you're an American firm, and you can justify why you should be exempt. And last I checked there were 30,000 applications, probably more than that now.

David Beckworth: And what happens is some bureaucrat, I think in the Commerce Department has to decide which ones get a pass, which ones do not. And I can just see firms, if they have the resources, sending someone up there and lobbying, petitioning.

Matt Mitchell: That's right.

David Beckworth: This to me would be another manifestation of rent seeking.

Matt Mitchell: That's right, and it's actually really relevant to sort of sub-development of rent seeking called rent extraction. So this is an idea that the late economist Fred McChesney developed in 1987, and then in a follow up book called "Money for Nothing" from 1997. And the idea here is okay, normal rent seeking is, I'm a policymaker, and I somehow contrive an exclusive privilege for you, or for somebody. I grant a monopoly, or protection. McChesney's insight is well sometimes policymakers hand out harm. And sometimes policymakers are the ones who actually initiate it.

Matt Mitchell: Often in the rent seeking literature it's like okay, I'm a policymaker and you come to me and ask for a privilege. Sometimes it's the policymaker themselves that comes up with the idea, and instead of handing out a privilege, they're handing out some sort of punishment, or harm. So an example, it's basically kind of the idea of nice company you got there, it would be a shame if something were to happen to it, right?

Matt Mitchell: So through the power of regulation, and through the power of taxation, governments have an ability to harm firms or industries, and what they can do is let it be known that well if you ingratiate yourself to us, you won't come to so much harm. Peter Schweizer has, he's not an economist but he's more of a journalistic approach to this. He has a book called Extortion that gives a lot of really nice real world examples of this. But it's members of the finance committee essentially sending out notices to people in finance that hey, we're contemplating some, people in Washington are contemplating some big changes, make sure you're at the table when this happens.

Matt Mitchell: Fred McChesney pointed out some that in California they actually have a term for this, the legislature, they call it a milker bill. And it's the idea of, you just float the idea of a bill in order to milk your constituents or anybody who might be harmed from it of campaign donations. So I think this is a really powerful extension of the rent seeking idea. It's sort of in some ways the mirror image of rent seeking. It shows the cost that can be-

David Beckworth: So rent seeking the firm goes to the legislator, asks for the resource or the privilege. Or it goes to the government in general. And rent extraction is when someone in government takes the initiative to get that same transfer.

Matt Mitchell: Takes the initiative, and usually rather than through handing out favors, they're threatening to hand out-

David Beckworth: Oh kind of reverses the stakes.

Matt Mitchell: Exactly. So McChesney's book is called Money for Nothing, and it's the idea of you give me money, and I won't do anything to you.

David Beckworth: Okay.

Matt Mitchell: So it's basically what the Cosa Nostra does, right?

David Beckworth: Right. So I recently had on the show Jesse Eisinger, and he has a recent book out on the financial crisis, and on the lack of prosecutions that occurred to the executives of these big financial firms. He shows us some more general pattern when executives and corporations do wrong, they have settlements with the government, no one goes to jail. He argues it sends a bad signal, it doesn't incentify better behavior, it just means you got to pay the bribe.

David Beckworth: And he also points out that many of the people of the Department of Justice at the SCC, what they'll do is they're careful, they're mindful of the fact that the people they're regulating may one day be their boss, and there's a lot of lawyers in the Department of Justice that then go work for a law firm that represents the very corporation or financial firm that they were prosecuting or regulating in the first place. So this gets this idea of regulatory capture, and how is this related to what we've been talking about?

Matt Mitchell: Yeah, so a lot of people in graduate school will hear, oh the idea of regulatory capture comes from George Stigler’s 1971 article "The Economics of Regulation." If you read a little bit deeper into it, you realize, actually with all due credit to Stigler, this idea was in the air and a lot of people were talking about it at this time.

Matt Mitchell: Actually what I think Stigler did is he offered maybe a slightly more nuanced version of it that's really not quite capture. So capture had been around as this kind of idea of pretty prominent among left scholars, Gabriel Coco had some really great economic history pieces looking at the Progressive Era, and how firms kind of came in and captured government.

Matt Mitchell: But if you just think about the term capture, it's connotes conquest. A private firm or entity comes in and wholly owns government, right?

David Beckworth: Okay.

Matt Mitchell: And so libertarians and socialists strangely enough, both kind of are drawn to this idea. Stigler’s idea is a little bit more nuanced, and it's more like regulations are supplied by regulators, and they're demanded by special interests. There are other special interests who demand less regulation, and sometimes two firms in an industry, or two different industries may have different views of regulations, right? One may want it, and one may not want it.

Matt Mitchell: And so he really was attempting to develop a little bit more of a sophisticated idea of what's the market for regulations. And so while I've sometimes used the word capture, I like the idea of this more nuanced Stigler idea that it's really more about market, it's not always that firms win, sometimes firms lose. But how can you analyze that and figure out where it came from?

David Beckworth: So is regulatory capture a bigger idea, and more widely, has it hit the mainstream more than say rent seeking?

Matt Mitchell: You know it's hard to tell. I'm not sure. I think that the term is easier for people to wrap their heads around, and so I suspect it probably to some degree it has, but nevertheless I still hear people on the left and the right with sort of a, I think both have a weird view of regulation. That in some ways I think there's less understanding about this in the public domain than there was in the '70s.

Matt Mitchell: So quite commonly you hear people on the right talk about, well regulations are bad for business. Well no not really, often regulations are there because businesses want them. And you hear people on the left say well regulations are good for consumers. Well no not really, often regulations are there because the businesses want them, and they impose costs on consumers.

Matt Mitchell: Whereas if you go back to the '70s, when Stigler was writing, there's a great article by Ralph Nader and Mark Green talking about runaway regulations as a way to protect firms and industries from competition. It seemed to me that at that point actually, there was a better understanding of the way that regulations can be anti-competitive.

David Beckworth: Very interesting to hear Ralph Nader was writing on this back then. Well let's end on an upbeat note if we can, because again this can make one very fatalistic, but your point earlier is well taken that it should sharpen our thinking, so that we're aware of these externalities in politics. Which have ultimately, again, going back to the earlier point, affect long term economic growth.

David Beckworth: We want to have rapid productivity growth, and we need to address these issues, and this idea of rent seeking helps us better articulate and think about it.

David Beckworth: You have some suggestions for institutions to limit rent seeking, can you speak to those?

Matt Mitchell: Yeah. So one suggestion would be if you think about the economic subsidy race that states are in, you can go to, and I've talked to some governors who say look, I understand the economics, I know that handing out a subsidy does not actually benefit the broader community that I serve. I know that it imposes more costs on taxpayers than it does benefits for the subsidy recipients. But I can't give it up because-

David Beckworth: So like Amazon would be a good example.

Matt Mitchell: Exactly. Yeah, and they'll say but I can't give it up because it looks good, it looks like I'm doing something for the business community, and for the economy of my state, and the governor of the neighboring state isn't going to give it up, so I can't do it.

Matt Mitchell: So this is a classic prisoner's dilemma. I think a good solution to this would be some sort of interstate compact. Whereby states say, agree okay we're not going to hand out a subsidy to firms that relocate in exchange for you not handing out subsidies. One way to do this would be to say essentially commit themselves to generality, which is a Hayekian term, or non-discrimination as a Buchanan term, and say any firm that locates in our state will pay the same rate as any other firm in our state.

Matt Mitchell: It could be zero, if you want to have a zero corporate income tax rate that's fine. But so long as every corporation, any entity that incorporates in your state has that same rate. This I think would allow states to compete with one another in Tiebout sense along better margins. Along trying to make themselves the best environment in which to do business.

Matt Mitchell: So that would be one solution, and that's sort of an institutional solution. I would also argue that we should have more of a cultural solution too. Which is the left and the right, there may be a lot that we disagree on, but everybody should agree that equity is pretty darn good idea. You know we don't have to agree, we can settle the debate about whether we should have equality of outcomes, maybe in another hundred years we'll settle that.

Matt Mitchell: But it's pretty widespread, widely accepted that governments should not pick winners and losers and play favorites. We can agree on that. And so I'd like there to be more of a public opposition to this kind of thing, and I think there's a political market for this too, the representative elect Alexandra Ocasio--Cortez has recently made some headlines opposing the Amazon deal. And it's going to benefit presumably some people in her state, but she's willing to bear that cost because there is I think it's touched a nerve, and a lot of people just offends their notions of equity.

David Beckworth: Well on that hopeful bipartisan note our time is up. Our guest today has been Matt Mitchell, Matt thanks for coming on the show.

Matt Mitchell: Thank you so much for having me.

David Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app, and while you're there please consider rating us and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening.

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