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Is Rent Seeking Always So Costly to Growth?
Give a Chance to F. List and J. Schumpeter

By xiaoyang

Paper prepared for European School of New Institutional Economics 2009,
18th-22nd May, Cargèse, France

Abstract: The Neo-classical rent seeking theory argues that rent seeking activities waste scarce social resources without increase social outputs and hence results in retarding economic development. This strand of studies adheres to the doctrine of resource allocation. This paper takes an alternative Schumpeterian approach towards rent theory and rethinks the implications of rent seeking theory on economic development in a world of uneven development. In Schumpeter’s economic development theory, entrepreneurs must be armed with sufficient funds in order to make innovation into practice. In a laissez-faire economy, producers in less-developed countries (LDCs) are likely in problems to accumulate sufficient funds when facing the intensive competition from their technologically advanced rivals from developed countries. If so, the latecomers would be suffered from lacking funds for technological catch-up. In this paper’s model, the late-comer entrepreneur invests a partial of his profits in requesting protectionist government policies, such as imposing a tariff on imports, in order to raising funds for future innovations and ultimately fills the technological gaps. Thus, the LDCs bear the short-term welfare losses but would be succeed in harvesting the long-term technological competitiveness and economic catch-up.

Key words: Rent Seeking; Tariff Protection; Innovation; Economic Development

JEL: O1; O31; O24


xiaoyang

Renmin University of China & Universität Bonn
Address: Zimmer 41-337, Hirschberger Straße 58-64, 53119 Bonn, Germany
Email: huang_yh@ruc.edu.cn; s3yahuan@uni-bonn.de

Acknowledgement: This work is supported by the fund of ‘985’ Project, Renmin University of China (‘Philosophy and Social Science Innovation Base: Chinese Economic Research’) and Research Funds for Post-graduate, Renmin University of China. I’d like to appreciate Chuan Wang, Zhigao Liu, Julie Yeung, Wenzhe Zhao, Yanbing Jia and a number of others who gave their comments on this paper. Special thanks go to Genliang Jia for his persistent inspirations. All possible remaining errors and omissions are solely my own.






   
   
   
   
   
1 Introduction

Economic rent, or rent, is the surplus of income of one resource over its opportunity cost. As a consequence of resource allocation, rent is not only the outcome of the choices of individuals or (and) interest groups, and it changes as well when technological innovations and institutional changes in presence. That makes the concept of rent be a centerpiece for economic development studies. The bridge over rent and economic development is the so-called rent seeking activities.  The present studies on rent seeking largely concentrate on the costs or losses caused by rent seeking activities, thus ignoring their revenue or benefits. Put it in another way, rent as a scare resource itself, its own productivity has generally being downplayed in the present literature. Our understanding on the relation between rent and economic development is limited by this methodological deficiency by large. Generally, when someone speaking of rent seeking, some ‘bad’ impressions and anecdotes follow naturally. Furthermore, the resulting economic policy turns to be biased inevitably. Turning to the real world, there are also plenty of paradoxes concerning rent seeking and economic development issue.   Historical evidences concerning how rich country got rich demonstrate that governmental-industrial links create rents ‘collusively’ and finally make economic development occur. Different from existing literature, this paper follows the Schumpeterian economic development scheme to study rent seeking and economic development. Rent is treated as a necessary condition for entrepreneur’s innovative attempts in our analysis. It is not only a simple outcome of some unproductive activities, but also an input for productive engagements. As a consequence, elite entrepreneur’s rent seeking activities may be helpful, intentionally or unintentionally, to economic development under some circumstances.

In economic literature, monopoly is always seemed as a twin brother of resources misallocation, aggregate welfare shrinking, and unequal income redistribution (Harberger, 1954). Terms, such as ‘dead-weight loss’ or ‘Harberger triangle’, were coined to measure the welfare loss caused by monopolistic powers. Skepticism towards earlier empirical results of estimation on the size of the welfare loss caused by misallocated resources (Harberger, 1954, 1959) triggered the emergence of the rent seeking theory, which was immediately employed in various economic analyses, such as Institutional Economics and Public Choice Theory. According to classical rent seeking works (i.e. Tullock, 1967; Krueger, 1974; Posner, 1975; Wenders, 1987), monopolistic super-normal profits attract competitive rent seeking or (and) rent-defending activities. This kind of activities which transfers resources (e.g., wealth) between social groups makes no difference to the wealth on social level, but this transfer process uses scarce resources while producing no outputs. Therefore, monopolies, and more broadly, regulations not only bring welfare loss, but also introduce social costs. Bhagwati (1982) promptly uses the concept of ‘directly unproductive profit-seeking’ (DUP) activities to make an earlier attempt to synthesize and categorize the distorted resources allocations and their welfare consequences.  To a large extent, this group of economists argues government regulations, such as trade and industrial policies, artificially create a ‘prize’ swinging in front of interest groups and induce investments in rent seeking activities that take the forms of bribes, corruptions, lobbies, black markets and smuggles, etc.

Towards the issue of economic development, the classical rent seeking literature generally adopts welfare analyses (e.g. Krueger, 1974). As it has been extensively applied to boarder fields sooner, the rent seeking theory collaborates with other economic theories and instruments in interpreting economic development. In the framework of institutional economics, Baysinger et al. (1980), Ekelund and Tollison (1980, 1981 and 1997) try to explain some paradoxes of mercantilist systems in history. They suggest that the differences of English and French political institutional arrangements lead to discrepant rent seeking costs of requesting monopolistic privileges from the two governments before the ‘Industrial Revolution’.    Tullock (1988a) argues that sharp reduce in patents and restrictive practices drew people from rent seeking activities to productive activities is an important reason for why “Industrial Revolution” happened in England. Olson proposes special interest groups retard the society’s ability to adopt new technologies and to reallocate resource during social changes, thus postpone the rate of economic growth (Olson, 1982: 65).   In the endogenous growth model of Rama (1993), the author explains the relation between rent seeking and economic growth through entrepreneurs’ binary choices between investment and lobby. The reason is that their decisions change the costs of regulations. Baumol (1990) suggests different rules of game provide distinct relative returns of productive and unproductive activities (e.g. rent seeking), and provides some interesting historical cases of rises of falls of countries to support his argument. Murphy et al. (1991) makes a similar point of view when interpreting a country’s the economic growth: if the talented people engage in production, they improve technology and enhance productivity; the other way around, when the talent is allocated in unproductive rent seeking, the income and growth would be damaged for certain reasons. In their later study, Murphy et al. (1993) proposes the rent seeking activities are subject to increasing returns ─ a marginal increase in rent seeking activity would make it more attractive than productive activity. Due to the increasing returns of rent seeking industry, a ‘good’ or ‘bad’ equilibrium that an economy would be reached depends on the relative returns of production and rent seeking. An economy where the property rights are well protected that reduces the revenue of rent seeking activity, and its growth is always better than other economies where property rights are protected poorly. Furthermore, innovative entrepreneurs are hurt much more badly by rent seeking (public rent seeking in particular) than normal producers. The authors conclude as their paper’s title that rent seeking is ‘so costly to growth’.

This kind of rent seeking theory is basically constrained in the Neo-classical framework, and limits its analyses on resource allocation and social welfare analyses. We call this type of rent seeking theory as the Neo-classical, or unproductive rent seeking theory. Many authors are eager to incorporate newly developed economic theories and models when applying the rent seeking concept to economic development studies, but remaining the static resource allocation approach of the Neo-classical economics. Some basic points are highly acknowledged in these studies. Firstly, rent-seeking activity is an alternative to productive activity, and the former could ‘crowding-out’ the later and thereof it hinders growth. Secondly, the state is viewed as a profit-maximizing group and government bureaucrats have incentives to raise revenue in legal (e.g. taxation) or illegal (e.g. corruption) rent seeking ways. Government regulations always lead to resource misallocation and influence people’s decisions on rent seeking and producing, because they distort the relative returns of these two activities, so it always plays a negative role in the drama of economic development. Thirdly, as a general policy implication, countries of minimum government regulations and well-protected property rights are ‘good’ for development, vice versa. For trade policy in particular, free trade is superior to protectionism with regard to that regulations provoke rent-seeking activities and results in poor economic growth. This string of rent seeking studies always cites ‘fallen’ countries as supporting evidences, such as Peru and Equatorial Guinea (Murphy et al., 1993).

When studying on economic history, history of economic thought and policy, there is, however, another obvious type of economic development tradition which is intimately related to rent theory (see Reinert, 1999, 2008; Chang, 2002, 2008; Reinert and Daastøl, 2004; Kaplinsky, 2005). Two pillars of this type of development theory are rent and barriers of entry, and the later is not just a shield, but also a necessary condition for the former. According to this development theory, different economic activities have higher or lower barriers of entry that make firms and states have different powers of monopoly, which determine their distinct abilities to extract rents from their activities. Concisely, development “is essentially a knowledge- and technology-based rent…” (Reinert, 2008: xxviii), so we can call this development doctrine as Evolutionary Development Economics. The theme of economic development is to build or circumvent barriers of entry of certain economic activities, then extracting rents from them. Due to their diverse capabilities in creating and extracting rents, development performance among countries turns out to be divergent: successful countries are able to gain rents through consistently building barriers of entry, especially in the way of innovation. If the industries can not build barriers of entry toward their foreign rivals, the role of state is to direct economy into activities (industries) of higher barriers of entry, with respect to other countries through, institutional rearrangements. More formally, economic policies should be used to ensure its industries are able to out-perform others, if the industries are not competent. One point should be noted, that this evolutionary development theory explains the world’s uneven development.  Countries are different agents, rather then social groups without ‘nationalities’ with in the Neo-classical rent seeking theory.

Regarding to trade policy, the ‘infant industry protectionism’ of Alexander Hamilton and Friedrich List (1841) of 19th century is the hardest bastion of the evolutionary development doctrine above.   According to this argument, manufacturing industries, a synonym of high technology for a fairly long history, have significant impacts on economy, politics and culture. The developing countries, like America and Germany at the time of A. Hamilton and F. List, need to protect their ‘infant industry’ from severe competition of developed countries, like Britain.  Only after the developing country’s industry is competitive to its counterpart in developed country, the free trade would be beneficial to both parts. Trade barriers and industrial promotion are indispensable policy tools that serve as  barriers of entry, with which foreign (not necessarily domestic) competition would be reduced. Hence, infant industry protectionist practices ‘artificially’ create rents for particular groups who can make the economic take-off.

Apparently, this type of development theory respects the effects of rent and monopolistic power on development, and values the positive role of state policies in promoting its domestic industrial competitiveness when it becomes necessary. More evidently, historical and today’s successful countries’ economic theory and policies are systematically adhere to this development tradition (see List, 1841; Reinert, 2004 and 2008; Reinert and Jia, 2007; Chang, 2002, 2008). During the 400 years from Henry VII’s inauguration in 1485 to 1846’s giving up the ‘Corn Law’, the English governmental policies had been heavily focus on protecting its wool and textile industry against low-land countries and India.  American government doubled tariff rate in 1812, from 12.5% to 25%, and rose to 35% in 1816 and generally kept at a level of 40%. In 1820, the average tariff of the U.K. and the U.S. was 40-45% and 35-45%, respectively, and the average tariff rate of the U. S. kept at 40% until the end of 1930s (Chang, 2002).  Hence, there is no evidence to support the two once and now world economic leaders got rich without intensive regulations on trade and industries. More recently, in the second half of 20th century, the economic ‘miracle’ created by East Asian ‘tigers’ under the lead of Japan and South Korea demonstrates the  ‘developmentalist state’ again. Governments intervene their economies to a large extent. Policy instruments, including government subsidies (taxes rebates, bank credits and foreign exchange access, etc.), prizes for the winner of export competition, restrictions on foreign capitals, are widely practiced to promote local technological capacity (Amsden, 1989; Chang, 2006). 

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