December 24, 2014

Government Handouts Hurt Business Like They Hurt You

Matthew D. Mitchell

Senior Research Fellow
Summary

The eminent political economist (and my former professor) Gordon Tullock, passed away last month at the age of 92. His greatest contribution to economic understanding was a funny-sounding concept: "rent seeking." Funny sounding or not, this idea-perhaps more than any other economic idea developed in the last century-explains what ails our moribund economy.

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The eminent political economist (and my former professor) Gordon Tullock, passed away last month at the age of 92. His greatest contribution to economic understanding was a funny-sounding concept: "rent seeking." Funny sounding or not, this idea-perhaps more than any other economic idea developed in the last century-explains what ails our moribund economy. And, as strange as this may sound, a pair of rock star dinosaur hunters from the 1880s can help us understand what exactly rent seeking is and why it's such a problem.

Some 150 years ago, dinosaurs were all the rage. After eons in limestone limbo, Triceratops, Stegosaurus, and Diplodocus emerged from oblivion to reclaim their erstwhile fame. The entrepreneurial scientists who unearthed them garnered glory as well. They won lucrative research grants, prestigious posts at universities and museums, and more earned media than a once-removed Kardashian cousin.

But the most famous of these paleontologists, Othniel Marsh and Edward Cope, resorted to a vicious form of competition that would ultimately bury their reputations along with an unknown quantity of dinosaur bones. Their story offers a lesson to today's entrepreneurs and policy makers about the consequences of rent seeking.

In any competition, it pays to be unique. Because his talents are rare, Michael Jordan amassed a net worth of over $1 billion. And because, for a while, Apple's iPhone was the only smart phone to act like a modern smartphone (with a touch screen, an app store, and computer-like functions), it too was able to earn an extraordinary profit. Economists refer to the above-normal profits of exclusive producers as "rents." But the term has nothing to do with apartments; you might think of it as another term for monopoly profit.

Unusually high profit can be a good thing. The potential for earning such profit encourages firms to innovate, to differentiate their products, and to become the best in their field. It also encourages those with rare talents, like Michael Jordan, to put those talents to good use, creating value for paying customers.

But exclusivity can be either natural or contrived and that makes all the difference as to whether its pursuit is socially beneficial or destructive. In the case of Apple or Jordan, the exclusivity was natural. All of the research and development to make an iPhone and the practice to make a jump shot were socially productive investments. They improved the user and viewer experience, and the world was better off because of them.

This was not so with the dino-hunters. Though they were once friends and even named dinosaurs after one another, Marsh and Cope's competition eventually grew nasty. When Cope put the head of a Plesiosaur on its tail rather than its neck, Marsh delighted in pointing out the error. When Marsh put the wrong skull on an Apatosaurus and declared it a new species called Brontosaurus (confusing the rest of us ever since), Cope was happy to trumpet the mistake.

This sniping, though impolite, was still socially beneficial as it advanced scientific knowledge. But as the New York Herald documented in a front-page article in 1890, the competition literally grew destructive. At one point, the men's employees threw stones at one another. At another point, each allegedly destroyed and/or re-buried an unknown number of specimens in order to keep them out of the other's reach.

By using fraud and force to literally destroy the competition's work, each man attempted to artificially contrive exclusivity. This type of investment-unlike research and development or time at the gym-is socially wasteful. It requires the expenditure of time, money, and effort. But it creates no new value for consumers. In fact, it destroys value even as it creates "rents" for the destroyers.

In pioneering work in the 1960s and '70s, Gordon Tullock and Anne Krueger drew economists' attention to the social costs of artificially contrived exclusivity. Given that the returns to exclusivity are called "rent," Krueger termed the attempt to artificially contrive exclusivity "rent seeking."

Those who seek rents today need not dynamite their competition. Instead, they can simply ask the state-with its monopoly on the legitimate use of force-to enact a discriminatory regulation, a tax on their competitors, or an exclusive privilege.

North Carolina's dentists are rent seeking when they claim consumers can't get their teeth whitened by non-dentists. Local car dealerships are rent seeking when they ask for regulations that make it illegal for manufacturers like Tesla to sell directly to consumers. Tesla itself is rent seeking when it asks Nevada to shell out $1.25 billion in tax privileges in exchange for building a factory in Reno. And Boeing is rent seeking when it asks taxpayers to guarantee loans to foreign firms that buy its planes.

In the decades since Tullock and Krueger developed the concept, hundreds of academic articles have documented the socially destructive consequences of rent seeking. Economist William Baumol showed that it misdirects entrepreneurial activity, limiting the discovery of new products and new techniques, and slowing the rate of growth. As the late economist Mancur Olson asserted, it may even explain why entire societies rise or decline.

Tullock would later note that rent seeking may not even be profitable for the firms that engage in it in the long run. They often expend so much money in an effort to get and maintain exclusive privileges that they are no better off for it. This was the fate of the paleontologist rent seekers. Despite decades of work and hundreds of discoveries, Othniel Marsh and Edward Cope both died penniless. With their reputations in shambles, they were the most prominent casualties of the bone wars.